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MONET

MONTENEGRO ECONOMIC TRENDS

June 2006

Monet June 2006

© Institute for Strategic Studies and Prognoses 1

Montenegro Economic Trends

2

© Institute for Strategic Studies and Prognoses

Dear readers, Montenegro has stepped into a new phase of its economic and democratic development. Individuals (citizens) have decisively shown that they want to take responsibility for their standard and quality of living. Montenegro jumped over the final obstacle that was in its way to improving economic and political freedom, to developing a free market, to protecting property rights, and to having individual freedom. The economic boom has already begun in Montenegro. The capital market, the institution that always reacts first, has “exploded”! Only several days after the historical decision was made, market capitalization increased by 30%. Investors are very interested to invest here. But, these positive trends warn us that serious work to improve economic freedom is mandatory and necessary. The enthusiasm of investors and entrepreneurs HAS TO BE supported by higher economic freedom and openness of Montenegro. This fact motivated us to conduct research and analysis in this volume in two key areas that directly influence business efficiency and profitability in Montenegro: transaction costs through payment operation fees, and the tax system. To increase economic freedom in these two categories, it is necessary to support the entrepreneurial and investment initiative. We hope that the information and analysis of the economic trends in Montenegro that are published in this volume of MONET will help you to make better decisions.

For Editorial Team Maja Bacovic, PhD

Monet June 2006


TABLE OF CONTENTS

EVENTS 4

MACROECONOMIC TRENDS 5

CHAPTER 1. REAL SECTOR 6

CHAPTER 2. EMPLOYMENT 12

CHAPTER 3. WAGES 19

CHAPTER 4. PRICES 24

CHAPTER 5. BUDGET 33

CHAPTER 6. MONEY 44

CHAPTER 7. CAPITAL MARKET 57

CHAPTER 8. EXTERNAL SECTOR 65

CHAPTER 9. REGIONAL COMPARISON 66

CHAPTER 10. INFORMATION COMMUNICATION TECHNOLOGY IN MONTENEGRO 69

RESEARCH 75

PAYMENT FEES 76

ANALYSIS 83

THEORETICAL APPROACH TO PROGRESIVE TAXATION 84

FLAT VERSUS PROGRESSIVE TAX FROM THE VIEW OF EQUITY 87

FISCAL POLICY AND STATE’S COMPETITIVE ADVANTAGE 90

THE IMPACT OF TAXES ON INVESTMENT ACTIVITY IN MONTENEGRO 98

TAX POLICY ON CAPITAL MARKET 102

TAX WEDGE ON THE WAGE LABOR COST - COMPARISON OF MONTENEGRO WITH SEE COUNTRIES 108COMPARATIVE OVERVIEW OF EXCISE DUTIES REGULATION IN THE EUROPEAN UNION AND MONTENEGRO 118

TAXES AND ECONOMIC FREEDOM 128

IMPLEMENTATION OF REDUCED VAT RATE IN TOURISM SECTOR 133

STATISTICAL ANEX 138


4


EVENTS

January 2006 Realized one more successful privatization – The Croatian company “PGM Ragus” and the Government of Montenegro signed a contract for the sale of Hotel “Galeb” for € 5.3 million. Additionally, another new privatization was begun. The Agency for Restructuring and Foreign Investments of Montenegro announced new Tender for the sale of 62.7% of the shares of the Adriatic Shipyard “Bijela”. The value of the company is estimated at € 33.61 million. The Montenegrin Parliament adopted a new law – Copy Right Law. The main goal of the Law is to provide complete and efficient protection of intellectual ownership rights. The Law is harmonized with the requests of the Republic, as well as WTO.

February 2006 This month was marked with the ratification of the contract between Montenegro and Microsoft Corporation. Microsoft will provide software licenses for the Montenegrin scientific institutions. This contract made Montenegro and Microsoft partners over the next three years. The famous Hotel on Zabljak – Planinka was sold this month. The hotel was purchased by a consortium of HLT Fund and HTP Primorje. The value of this transaction was € 2 million. For the first time, Montenegro established a Council of the Statistical System of Montenegro. This institution should contribute to reforms in this area and accelerate the transformation and modernization of the Statistical Office of Montenegro. According to an announcement of the Ministry of Agriculture, the Agro budget in 2006 is planned at € 32.5 million.

March 2006 The Privatization Council of Montenegro announced an auction for the sale of the company “Secas”. The starting price for the company is € 276.6 thousand. The Institute for Strategic Studies and Prognoses organized the first School of Statistics. This school is realized with the support of MONSTAT - Statistical office of Montenegro and the development Agency of Montenegro. The Montenegrin Investment Promotion Agency (MIPA) became a full member of the World Association of these institutions, which should provide direct presentations of the investment potential of Montenegro to the most attractive investments, properties, and pension funds.

April 2006 April finds a positive prognosis for Montenegrin tourism. According to the prognosis of the World Tourism and Traveling Council (WTTC), Montenegro will generate around € 770 million from tourism and linked economic activities from next year to the year 2016. The Montenegrin capital market was, during the presentation to the Slovenian and Croatian investors, evaluated as ideal for investments in terms of the legal safety, regulation, and undervalued shares. Competition on the Montenegrin capital market will be intensified due to the introduction of one more broker-dealer house – Moneta, in which the majority owner is the similar fund. In Milocer, a Conference of the Group of Bank Supervisors from Central and Eastern Europe was held. The main goal of the Group is to improve the stability of the region’s banking system through the exchange of techniques, experience, and information. As a stimulus for the development of entrepreneurship in Montenegro, the Employment Office, SME Agency, and Development Fund approved a total of 481 credit lines totaling € 250 thousand.

Monet June 2006


MACROECONOMIC TRENDS


6


CHAPTER 1. REAL SECTOR

The total economic activity in the first quarter of 2006 was higher as compared to the same quarter of the previous year due to higher activity in the sector of tourism (increase in the number of tourists by 37.2%), transportation of goods (growth rate of 31.3%), transportation of passengers (growth rate of 7.9%) and construction (growth rate of 46.8%)1. Moreover, industrial production, as an important contributor to the overall economic activity in Montenegro, increased by 4.4% in the first quarter of 2006 as compared to the first quarter of 2005, and together with higher services production, it contributed to the growth within the real sector of the economy.

Graph 1.1. Situation in the real sector (seasonal adjusted 1998=100)2

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Source: Monstat; Index of activities in the real sector calculated by ISSP 1.1 INDUSTRIAL PRODUCTION 1.1.1. Industrial production Industrial production in the first quarter of 2006 was 4.4% higher than in the first quarter of 2005. In March of 2006 industrial production increased by 3% compared to March of 2005. The main determinants of the increase in industrial production in the first quarter of 2006 were the growth in production within several sub-sectors of the processing industry, such as wood processing, food processing, beverage production and textile production, as well as the increase that was marked in the sector of mining and stone extracting. 1 Measured by the value of construction activities. ISSP estimated data for the first quarter of 2006 based on official data from Monstat inclusive with January 2006. 2 Graph 1.1 presents the seasonal adjusted data of activities in the real sector. Aggregated index, which presents activities in the real economy, consists of weighted indices of industrial production, transport of goods, transport of passengers, retail trade, forestry, tourism, catering and construction. This is due to the fact that these sectors, within the real economy, participate on average around 50-55% in GDP.

Industrial production in the first quarter of 2006 increased by 4.4% compared to the first quarter of 2005. Production of services, which makes more than 54% of GDP, increased in large part due to the following services: o Transport of goods and transport of

passenger; o Higher number of registered tourists; o The real growth of catering and retail

trade.

Monet June 2006


Three major industrial sectors Production within the processing industry sector, which represents 70.6% of the total industrial production, was 2.4% lower in the first quarter of 2006 as compared to the first quarter of 2005. The annual growth rate of production in the processing industry was 1% in March 2006. The main contributors to the decreased production in the processing industry in the first quarter of 2006 compared to the same period of 2005 were a lower level of production in: manufacture of tobacco (a decrease of 76.6%), chemical products and fibers (a decrease of 41.8%), and manufacture of transport equipment (a decrease of 1.3%). The sub-sector “Manufacture of textile and textile products” represents 1.2% of total industrial production and increased its production by 7.4% in the first quarter of 2006 as compared to the first quarter of 2005. Production within one of the major sub-sectors of the processing industry, “basic metals and metal products manufacturing” (42.6 % of total industrial production), increased its production by 3.4% in the first quarter of 2006 compared to the first quarter of 2005 and by 2.6% in March 2006 compared to the same month of 2005. Production of the sub-sector “Manufacturing of products of other non-metal minerals” (6.1% of total industrial production) increased in the first quarter of 2006 by 0.5% compared to same quarter of 2005, and by 3.3% in March 2006 compared to the same month of 2005. The industry “food products and beverages” (7.1% of total industrial production) increased its production by 18.8% in the first quarter of 2006 compared to the same period of 2005. This production increased by 4.1% in March 2006 compared to the same month of 2005. The sub-sector “Wood processing and wood products,” which accounts for 2.2% of total industrial production, increased its production in the first quarter of 2006 by 165.6% compared to the same quarter of 2005, and by 453.1% in March 2006 compared to the same month of 2005. Production within the sector of “Manufacturing of paper; issuing and printing” (1% of total industrial production) increased by 20.1% in the first quarter of 2006 as compared to the same quarter of 2005 and by 16.9% in March 2006 compared to the same month of 2005. The second major industrial sector, electricity, gas and water, which accounts for 23.3% of total industrial production, saw its production increase by 13.2% in the first quarter of 2006 compared to the first quarter of 2005. The annual growth rate of its production was 7.3% in March 2006. The sector of mining and stone extracting, which accounts for about 6.1% of total industrial production, increased by 46.6% in the first quarter of 2006 as compared to the same quarter of 2005. The annual growth rate of its production in March 2006 was 8%. Leading industrial producers One of the most important industrial producers - The Power Company of Montenegro (Elektroprivreda Crne Gore) produces electricity, which accounted for approximately 20% of total industrial production in Montenegro. This company increased its production by 13.2% in the first quarter of 2006 as compared to the same quarter of 2005. The annual growth rate of its production was 7.3% in March 2006. Graph 1.2 presents the aggregate planned and actual electricity production of the three power plants existing in Montenegro: Perucica Hydro Plant, Piva Hydro Plant, and Pljevlja Thermal Plant.


8


Graph 1.2. Total elecricity production

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Source: The Power Plant of Montenegro (EPCG)

Total actual production of the three plants in the first quarter of 2006 was 7.28% above the planned level. Total actual production of the two hydro plants in the first quarter of 2006 was 715,043 MWh, or 71.2% of the total executed electricity production. The remaining production came from the thermal plant Pljevlja.

Total actual production of the Perucica Hydro Plant was 23.39% above the planned level in the first quarter of 2006. Actual production of the Piva Hydro Plant also exceeded the planned level by 8.7 % in the first quarter of 2006.

Actual production of the Thermal Plant Pjevlja was 30.1% above the planned level in the first quarter of 2006. Generally, appropriate delivery of coal to this plant is the main reason for realizing production of the Thermal Plant. Despite the fact that the power company of Montenegro has been reconciling its obligation, in the coalmine, Pljevlja hasn’t provided the necessary level of liquid assets to realization production. In addition to that, the problem of accuracy of the mining equipment and plant should be emphasized.

Total executed electricity production in the first quarter of 2006 was 27.6% lower as compared to the same period of 2005.

Graph 1.3. Dynamics of electricity production

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Source: EPCG Note: 12-month averages of annual changes are moving averages of annual changes during the past 12 months

Monet June 2006


Aluminum production in the first quarter of 2006 was at a similar level as in the first quarter of 2005. This production was 1% lower in the first quarter of 2006 as compared to the previous quarter. Generally, one reason for the stagnation of aluminum production in the first quarter of 2006 was the privatization process of KAP, as well as its problem among the syndicate and management of KAP.

Graph 1.4: Aluminum producion and exports prices

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Source: KAP Aluminum production, as graph 1.4 presents, increased in 2004, but it decreased a bit in 2005 and in the first quarter of 2006. The average monthly aluminum price has been rising quite quickly, to 2,377 $/ton in January 2006, and it continued to grow in February (2,455 $/ton), while declining a bit in March (2,429 $/ton). 1.2 FORESTRY AND CONSTRUCTION Forestry Estimated production in the forestry sector increased by 35.7% in the first quarter of 2006 compared to the same quarter of 20053. However, it should be emphasized that production in the forestry sector strongly declined in the first quarter of 2005 because of very bad weather conditions and while in the same period of 2006 this production increased, it is still on the low level. Estimated production in the forestry sector declined by 96.8% compared to the fourth quarter of 2005.

3 Due to the fact that official data about activity in the forestry sector were available for the first month of 2006 only, the ISSP estimated this production for the first quarter of 2006.


10


Construction Average production in the sector of construction, measured by the value of the constructor’s activities, was 46.8% higher in the first quarter of 2006 compared to the same period of 20054. However, activities within the construction sector decreased by 42.1% in the first quarter of 2006 compared to the last quarter of 2005, which can be explained by very bad weather conditions. 1.2 SERVICES

Tourism In the first quarter of 2006, the total number of tourists was 40,003 and increased by 37.2% compared to the same period of the previous year. The number of domestic tourists was 24,254 in the first quarter of 2006 and increased by 22% compared to the same quarter of 2005, while the number of foreign guests was 15,749 in the first quarter of 2006 and increased by 53% compared to the first quarter of 2005. In the first quarter of 2006, the share of foreign tourists was 39.03%.

Graph 1.5: Number of tourists in Montenegro

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OTHER SECTORS OF SERVICES Transport Estimated transport of goods increased by 31.84% in the first quarter of 2006 compared to same period of the previous year, while compared to the last quarter of 2005, average transport of goods decreased by 12.4%. Estimated transport of passengers increased by 15.2% in the first quarter of 2006 compared to same period of the previous year, while compared to the last quarter of 2005 average transport of passenger decreased by 22.5%.

4 Due to the fact that official data about construction activities were available for the first month of 2006 only, the ISSP estimated this production for the first quarter of 2006.

Monet June 2006


Graph 1.6: Transport of passengers and goods (seasonal adjusted 1998=100)

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Retail trade The ISSP estimated retail trade turnover for the first quarter of 2006 based on monthly data obtained from Monstat, which concluded with January 2006. The average retail trade turnover nominally increased by 28% in the first quarter of 2006 compared to the same quarter of 2005. In real5 terms, retail trade turnover increased by 24.4% in the first quarter of 2006 compared to the same period of the previous year. Catering The average level of catering turnover in the first quarter of 2006 was 119.4% higher than in the same quarter of 2005. In real terms, catering turnover increased by 113.2% in the first quarter of 2006 compared to the first quarter of 2005. 1.3. FORECAST FOR 2006 According to the ISSP prognosis, industrial production in 2006 will increase by 2.1% compared to the previous year. An increase of industrial production is expected due to increased production in the sectors of food products and beverages, aluminum production, production in the wood industry, as well as realization of the planned level of electricity production. The projected increase of total economic activity in 2006 is 15% compared to 2005; this increase is expected as a result of increases in industrial production, number of tourists, transport, retail trade and catering, activity in the construction sector, as well as financial services.

5 Deflated by CPI


12


Table 2.1: Employment

Total number of employed

persons 1

Unemployment rate %

(estimate)

2005 194,426 19.7 Q1-05 191,161 20.8 Q2-05 192,754 20.0 Q3-05 198,123 19.0 Q4-05 195,666 18.4 Q1-06 195,861 18.3

Source ISSP

CHAPTER 2. EMPLOYMENT

In the first quarter of 2006, according to ISSP estimates, employment grew by 2.4% in annual terms

2.1. EMPLOYMENT In the first quarter of 2006, the average number of employed persons, according to ISSP estimates, reached 195,861 persons. In the first quarter of 2006, relative to the previous quarter, ISSP estimates employment to have increased by just 0.1%, while as compared to the first quarter of 2005, employment was 2.4% higher. The sources driving the increase in employment in the first quarter of 2006 are probably the large inflow of FDI’s in 2005, as well as the growth achieved in some sectors of the economy (tourism sector).

This increase in employment has caused a slight decrease in the unemployment rate, by 0.1 percentage point; so, in the first quarter of 2006, ISSP estimated the unemployment rate at 18.3%.

Graph 2.1: Number of employed persons (2001-2006)

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Source: ISSP

Government activities to increase employment The government of Montenegro has launched a new program called “Chance for young”, according to which the government will subsidize 500 new jobs/apprenticeships for young people who have completed high school, college and a university education. The program began in February of 2006 and it should be completed by the end of April; anyone interested in this program, both employees and employers, should apply. The preliminary cost of this program is assessed at €1 million. Also, the Employment Office has announced that they will propose new tax relief for the newly employed individual, similar to the program that existed two years ago1. What will be the results? Although these two programs seem rather attractive, we must keep in mind that these are only short-term solutions.

Monet June 2006


The government should permanently reduce the fiscal burden on the labor cost, which could have a long-term positive impact on the employment situation in Montenegro. From 2002 to 2005 the tax wedge on the labor cost decreased by 4 percentage points, and at the same time, registered employment increased by over 3,500 people. On the other hand, subsidized jobs are only a short-term solution to the unemployment problem, especially among young people. Many employers will welcome employees free of charge, but it is questionable whether they will keep them after the end of the program. One of the solutions to reduce unemployment among the young, as well as within other categories of the unemployed, is to make labor regulations more flexible. This will, as in the case of Slovakia1, have many positive effects on the economy - the inflow of FDI’s as well as domestic investments will increase due to reduced barriers for doing business, and this will lead to a decrease in unemployment (since there are no barriers to entering and leaving a labor contract). There are no short-term measures that could reduce unemployment in the short term. Economic theory has shown that active labor market measures (such as subsidized jobs, trainings, loans for unemployed, etc) do not actually solve the problem of unemployment, they only pose as a government intervention on the labor market that should correct the effects of government intervention aimed at preserving jobs. So instead of correcting the effects of its interventions on the labor market, the government should set some basic rules of the game and let the market work. Improved (flexible) labor market regulations could contribute to the reduction of unemployment and allow the economic progress seen in Montenegro to be reflected on the labor market through lower unemployment and more jobs in the registered economy.

What official statistics say?

The official source of data on the unemployed is represented in an unemployment registry maintained by the Employment Office. According to this data, registered unemployment in Montenegro is continuously decreasing. In the first quarter of 2006 there were 48,894 registered unemployed persons, which is 16.6% lower relative to the same period last year. As compared to the previous quarter, unemployment in the first quarter of 2006 was 2.2% lower.

Graph 2.2: Number of unemployed persons (2000-2005)

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Source: Employment Office of Montenegro

Observing month-to-month changes, unemployment in January was 0.4% lower as compared to December, while in February unemployment remained constant, and in March it increased by 1.5% as compared to February.


14


Graph 2.3: The official number of employed, unemployed persons and pensioners (1994Q1-2005Q4)

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Source: Monstat, Employment Office of Montenegro and ISSP Note: data are quarterly averages However, the number of registered unemployed does not give a realistic picture of unemployment in Montenegro, but rather it shows the number of persons that receive the benefits of the government programs that are provided to unemployed persons (health insurance, unemployment benefits, etc). 2.2. ISSP HOUSEHOLD SURVEY RESULTS In December of 2005, ISSP conducted a household survey that included 1,450 households and 5,240 individuals from all Montenegrin municipalities. The survey sample included both urban and rural households.

2.2.1. Labor market indicators based on the survey results

During the previous week, according to the survey results, 36.7% of interviewed individuals were working or assisting in generating income, while 7.6% of the individuals stated that they were looking for a job, implying that out of the total Montenegrin population, 44.3% were active (working or looking for a job). More than one-fifth of those interviewed were attending school (23.2%), while 11.7% were at home not working, 13.3% were pensioners, and 7.5% were younger than 6 years of age (or have listed something else).

The labor force participation rate, which shows the portion of the working age population that is active, was 58.0% in Montenegro. The highest labor force participation rate was recorded in the Southern region (60.6%), while the lowest labor participation rate was recorded in the Northern region (56.5%). The participation rates of the male labor force are higher than the participation rates of females, by approximately 15 percentage points. The highest participation rate among both males and females is recorded in the southern region (68.8% and 53.1%, respectively).

However, the young population in the Northern region seems to be the most active, since the labor force participation rate for youth is 31.1% in the Northern region, meaning that 31.1% of the population between the ages of 15 and 24 are either working or looking for a job. About 53% of the working age youth population in the northern region were enrolled in the education system and approximately 15% of them were inactive. The participation rate of the youth labor force in the southern region is also close to 30% and about 52% of the young people are attending schools, while in the central region, just 21.3% of the youth population is active, but

Monet June 2006


close to 70% of the individuals between the ages of 15 and 24 are attending school and only 10% are inactive. Table 2.2: Basic labor market indicators (December 2005)

Montenegro Northern region Southern region Central region

%

Activity indicators Labor force participation rate (activity rate) 58.0 56.5 60.6 58.3

Male labor force participation rate 65.1 63.8 68.8 64.4 Female labor force participation rate 51.3 49.4 53.1 52.8 Youth labor force participation rate 27.4 31.1 29.1 21.3

Employment indicators Employment to population ratio 36.7 33.20 41.10 38.80

Employment rate 49.1 43.9 52.3 50.7 Male employment rate 54.6 50.3 61.0 56.4

Female employment rate 41.7 37.7 44.2 45.5 Youth employment rate 15.8 14.0 18.8 16.6

Unemployment indicators Unemployment rate 17.0 21.7 13.7 13.0

Male unemployment rate 15.8 20.6 11.0 12.3 Female unemployment rate 18.6 23.2 16.9 13.8

Youth unemployment rate (15-24) 37.8 50.3 32.9 20.2

Source: ISSP Household Survey, December 2005 Note: The following definitions are used: -Labor force participation rates are calculated as share of labor force (employed + unemployed) in total working age population (population aged between 15 and 65). -Employment to population ratio is the share of employed in total population. -Employment rates are calculated as a share of employed in the total working age population (population aged between 15 and 65). -Unemployment rate is calculated as a share of unemployed in active population/labor force. The employment to population ratio, or share of employed in the total population, indicates how many persons one employed person supports. In the northern region, one employee supports 3 persons including themselves, while in the central region, one employee supports 2.6 persons and one employee supports 2.4 persons in the southern region. Compared to some advanced economies, the employment to population ratio in Montenegro is still low, but it is improving (according to previous household survey results, one employed person in Montenegro supported 3.5 persons). On the other hand, the employment rate suggests that approximately 50% of the working age population is employed. If observed by gender, the employment rate among males in Montenegro is 54.6%, while it is 41.7% among females. According to survey results, unemployment among males in Montenegro in December 2005 was 15.8%, while unemployment among females was 18.6%, implying that the difference between males and females is lessening (in previous years, the female unemployment rate was 5 to 6 percentage points higher than that of males). The highest unemployment rates, for both males and females, are recorded in the northern region, amounting to 20.6% and 23.2%, respectively. The lowest unemployment rate for males was recorded in the southern region (11.0%) while the lowest female unemployment rate was recorded in the central region (13.8%). Unemployment among the young population is quite high – 37.8% on the state level; however, this is not worrying considering the international standards6 whereby unemployment among the young population is usually twice as high as the unemployment rate among adults (aged between 25 and 65). In Montenegro, the unemployment rate among adults is 16.6%, which

6 For details see www.ilo.org - Key labor market indicators.


16


means that unemployment among the young population is somewhat higher than in developed countries. The lowest unemployment rate among the young population is recorded in the central region (20.2%) while highest the unemployment is in the southern region (50.3%). These differences among regions, in terms of youth unemployment, also reflect the activity of youth labor, since the lowest activity rate of the young population is also recorded in the central region. However, this is also an indicator that young people are experiencing difficulties in finding jobs, especially in the northern region; while the activity rate in the southern region is similar to that of the northern region, the unemployment rate is significantly lower. 2.2.2. Some characteristics of employed and unemployed persons According to survey results regarding the gender structure of the employed and the unemployed (graphs 2.4 and 2.5), it is clear that the majority of the employed are male while among the unemployed, the share of males and females is nearly equal, with smaller differences between regions.

Graph 2.4:Structure of people working by gender

0

10

20

30

40

50

60

Montenegro North South Center

Male Female

Source: ISSP Household Survey, December 2005

Graph 2.5:Structure of unemployed by gender

0

10

20

30

40

50

60

Montenegro North South Center

Male Female

Source: ISSP Household Survey, December 2005

Monet June 2006


In terms of education, unemployed persons are more likely to have stopped at a high school education while employed persons are more likely to have a college or university education. This implies that people with a higher education have a better chance of getting a job, and conversely, people with less education have a higher chance of being unemployed. Table 2.3: Structure of employed and unemployed persons by education

Employed Unemployed

Without school 1.0 0.3

Incomplete primary school 1.6 1.3

Primary school 4.1 6.5

High school 61.5 73.0

Special school 0.3 -

College 13.9 8.3

University 17.6 10.6

Total 100.0 100.0

Source: ISSP Household Survey, December 2005 Considering the age structure of both groups (employed and unemployed), those between the ages of 19 and 30 years represent the largest share of the unemployed (48.3%), while among the employed, this age group accounts for just 26.5%. Persons between 31 and 40 years of age are represented equally among both groups (25.1% among the employed and 24.0% among the unemployed). Persons between the ages of 41 and 50 represent 27.7% of the employed population and 18.8% of the unemployed population. It is obvious that with age, the willingness of persons to look for a job decreases. Table 2.4: Structure of employed and unemployed individuals by age

Employed Unemployed

Average age of employees 39.7 32.8

Do 18 0.7 2.6

19-30 26.5 48.3

31-40 25.1 24.0

41-50 27.7 18.8

51-65 18.7 6.3

Over 66 1.3 -

Total 100.0 100.0

Source: ISSP Household Survey, December 2005 Among the working population, more than four-fifths (83.6%) were employees, while 7.3% were self-employed, 4.3% were owners/co owners of a business, and 4.8% were unpaid family workers. The share of self-employed individuals is highest in the Northern region (9%) as well as the share of business owners (5.1%) and unpaid family workers (9.4%). Table 2.6: Structure of employees by status

Montenegro Northern region

Southern region Central region

Employee 83.6 76.5 86.7 90.2

Self-employed 7.3 9.0 7.1 5.3

Owner/co owner of business 4.3 5.1 3.7 3.6

Unpaid family worker 4.8 9.4 2.5 0.9

Total 100.0 100.0 100.00 100.00

Source: ISSP Household Survey, December 2005 The share of employed individuals with employee status is highest in the central region (90.2%), while the share of unpaid family workers is lowest in this region (0.9%).


18


Table 2.6: Structure of employees by activity

%

Industry 13.26 Agriculture and fisheries 1.24 Forestry 2.20 Water supply 0.82 Construction 3.43 Transport and communications 7.14 Retail 12.71 Wholesale 3.09 Catering and tourism 8.24 Communal services 1.72 Public administration 15.32 Education 11.20 Health 7.49 Banking and finance 3.57 Real-estate 0.14 Other services 8.45 Total 100.0

Source: ISSP Household Survey, December 2005 The greatest proportion of employed individuals are still engaged in the public services sector, namely 34% of the total number of employed persons are engaged in some public service activity (education, health, administration). The second largest employer is the industry sector with 13.26% of total employed individuals, and it is closely followed by retail trade activity (12.71%). Also, a substantial share of employees is engaged in tourism activity (8.24%), transport activity (7.14%) and other services activities (8.45%). 2.3. LABOR PRODUCTIVITY IN INDUSTRY Labor productivity within industry in Montenegro is calculated based on official data on the number of employed persons in industry and on the industrial production index. According to available data, labor productivity in industry in the first quarter was 3% higher as compared to the same period last year. This increase in labor productivity is attributed to increased production, since there were no significant changes in the level of employment. Also, relative to the previous quarter, labor productivity in industry has increased by 1.5%. An alternative measure of labor productivity, on the economy level, is GDP per employed person. This measure of productivity measures the productivity of all persons employed in the economy. In Montenegro, since 2003 and onwards, the GDP per employed person, or labor productivity, has been increasing. In 2003, the GDP per employed person increased by 2.2% relative to 2002. Also, in 2004 labor productivity measured in this way also increased by 2.2%. In 2005, labor productivity measured as real GDP per employed person increased by 4.7%.

Graph 2.4:Industrial production and employment indices(2004=100)

40

60

80

100

120

140

J-04

M-0

4

M-0

4

J-04

S-04

N-0

4

J-05

M-0

5

M-0

5

J-05

S-05

N-0

5

J-06

M-0

6

Index of productionIndex of employment

Monet June 2006


CHAPTER 3. WAGES

3.1. WAGES AND SALARIE

Average wages in Montenegro in the first quarter of 2006 grew by 15.5% annually in nominal terms, or by 12.6% in real terms

The average wage in the first quarter of 2006 amounted to €343.39, while the average wage after taxes and contributions amounted to €223.71. As compared to the same period last year, average wages recorded a high annual increase of 15.5%. However, as compared to the previous quarter, the average wages in the first quarter of 2006 are 2.7% lower, which is mainly caused by a strong increase in wages in December of 2005. In January, the average wage recorded a 17.3% decrease as compared to December of 2005, while wages in February and March increased by 13.0% and 2.5%, respectively, relative to the previous months. In annual terms, average wages in all three months recorded strong growth rates of 10.5%, 18.3%, and 17.3% in January, February, and March, respectively. The increase in average wages that have been recorded in the last several years cannot be explained by inflationary pressures, since the inflation in Montenegro is stabilized at a relatively low level (1.8% in December 2005 relative to December 2004, and 4.3% in December 2004 relative to December 2003, as measured by the retail prices index). Also, the minimum wage remained stable as well. However, there are two possible explanations for this situation, which most probably had a positive influence on wage dynamics. The first factor that led to an increase in average wages is the increase in labor productivity, measured as GDP per registered employed person. (The reason for using registered employed persons to measure labor productivity is because the official wage statistics are related only to registered employees and their wages). In the period from 2002 until 2005, labor productivity measured by GDP per employed persons increased by 22.6% in nominal terms, or by 6.6% annually. In 2004, relative to 2003, labor productivity increased by 6.5%, while in 2005 the increase amounted to 6.5% (in real terms, it increased by 2.2% and 4.7%, respectively). The expected increase in labor productivity in 2006, based on projected GDP and registered employment, will be 5.94% nominally or 2% to 3% in real terms. The second factor that probably contributed to the increase in registered average wages is the decreased tax burden on labor, and as a consequence, the decreased level in the shadow economy on the labor market. Namely, in the period from 2002 to 2005 the fiscal burden imposed on labor (measured by the tax wedge indicator7), was reduced by approximately 3 percentage points. The reduction in the tax burden allowed for employers to register higher portions of their employees’ wages; it is very well known that employers usually register lower amounts of employees’ wages due to the high fiscal burden. 7 For details see sub-chapter Average tax wedge on the labor cost, in this chapter

Table 3.1: Average wages of employees

Min

imum

w

age

Aver

age

wag

es o

f em

ploy

ee

Aver

age

wag

es

with

out

taxe

s an

d co

ntrib

utio

ns

Aver

age

pens

ion

(pai

d )

2003 50.0 271.2 174.0 113.0 2004 50.0 304.1 195.4 122.0 2005 50.0 326.5 213.1 128.2 Jan-05 50.0 283.4 185.1 124.6 Feb-05 50.0 299.2 196.4 124.6 Mar-05 50.0 309.4 203.0 128.7 Apr-05 50.0 325.6 212.2 128.6 May-05 50.0 297.8 191.6 128.7 Jun-05 50.0 329.6 214.7 128.7 Jul-05 50.0 329.8 215.8 128.7 Aug-05 50.0 338.8 220.5 128.7 Sep-05 50.0 336.5 219.4 129.1 Oct-05 50.0 336.9 219.6 129.1 Nov-05 50.0 343.3 223.6 129.1 Dec-05 50.0 378.8 253.7 129.1 Jan-06 50.0 313.2 205.2 136.8 Feb-06 50.0 354.1 230.3 136.8 Mar-06 50.0 362.9 235.6 136.8

Izvori: Monstat, Fond PIO


20


Bearing in mind that inflation is stabilizing despite the recorded high increase in wages, which are usually assessed as one of the main inflationary factors especially if the increase in wages is not caused by an increase in productivity, the two presented explanations could be regarded as quite realistic.

Graph 3.2. Annual growth of nominal and real disposable wages

-10.0%

0.0%

10.0%

20.0%

30.0%

40.0%

50.0%

60.0%

Jul-0

3

Sep-

03

Nov

-03

Jan-

04

Mar

-04

May

-04

Jul-0

4

Sep-

04

Nov

-04

Jan-

05

Mar

-05

May

-05

Jul-0

5

Sep-

05

Nov

-05

Jan-

06

Mar

-06

Annual growth of real disposable wages Annual growth of nominal disposable wages

Sources: Monstat and ISSP calculations As a consequence of low inflation and high wage growth, the increase in real wages or the dynamics of real wages over the last two years is close to that of the nominal growth. In 2006 this trend has continued, so the nominal growth of wages is slightly higher than real growth. In real terms, average wages have increased by 9.0% in January, 14.9% in February, and 13.8% in March, relative to the corresponding periods of last year. The average real annual growth of wages achieved in the first quarter was 12.6%. The trend in average wages recorded in the period since 2004 combined with the wage level in the first quarter of 2006 leads to the expectation that average wages will continue to record high annual growth rates. If average wages achieve minimal growth rates on a monthly level of 0.1%, then the annual level of average wages in the second quarter of 2006 will increase by 14.5%. On the other hand, if average wages experience similar growth rates as those in 2005, the expected annual increase in the second quarter of 2006 will be 8.0%. 3.2. WAGES AS A HOUSEHOLD INCOME SOURCE According to the results of the ISSP household survey conducted in December 2005, among 1,450 households from all over Montenegro, wages are the most important source of a household’s income. The average wage income per household in Montenegro in December 2005 amounted to €462.52, which was 77.7% of the total average household monthly income. The average monthly income of households amounted to €595.31; this amount includes wages from both main and secondary jobs, social transfers (pensions, social assistance, unemployment benefits, etc), income from agriculture, sale of property, transfers from friends and relatives, etc.

Monet June 2006


Table 3.2. Average income of households (December 2005)

Montenegro Northern region

Central region

Southern region

In €

Average wage income per household8 462.52 354.07 496.75 567.29 Average total monthly income of households 595.31 462.24 652.16 729.09 Share of wage in the total monthly income 77.70 76.60 76.17 77.81 Average number of employed persons per household 1.3 1.3 1.3 1.3

Sources: ISSP household survey, December 2005

The northern region records the lowest total household income, with an average of €462.24, and 76.7% of this amount is earned through wage income (€354.67). The highest average household income was recorded in the southern region and amounted to €729.09 per month, while the wage income in this region amounted to €567.29, which is 77.8% of total household income.

In the central region, the average monthly household income amounted to €652.16, while the wage income per household was €496.75 or 76.2% of total household income.

3.3. AVERAGE TAX WEDGE ON THE LABOR COST An indicator called a tax wedge measures the fiscal burden imposed on labor costs. The tax wedge represents the percentage share of paid contributions and taxes in the total labor cost. The lower the tax wedge, the lower the fiscal burden on labor costs. In the first quarter of 2006 the tax wedge was 39.8% on average. In January, due to a lower average wage, the tax wedge amounted to 39.1%; in other words, out of the total labor cost, 39.1% was allocated to taxes and contributions while the remaining 60.9% was received by employees. In February, the tax wedge increased to 40.2%, while in March it was at 40.3%. The level of the tax wedge changes according to the changes in average wages. Namely, since the progressive tax is applied in Montenegro, an increase in the

average wage leads to a higher tax wedge, since the amount of paid income tax increases. This is true if there are no changes in the level of tax rates and tax brackets. If the Government of Montenegro decides to reduce the personal income tax by introducing a flat rate of 15% and exempt income of €70 per month, the tax wedge will be reduced by approximately 5 to 6 percentage points.

8 Data related to incomes are only asked on the household level, so the average wage per employee is not available. Also, the data on incomes of households should be used cautiously, since respondents tend not to provide accurate data on their income level.

Table 3.3. Effective PIT rate and the tax wedge

Average effective tax rate (%wages

and salaries)

Tax wedge on labor

2005 13.5 40.4 Jan-05 12.5 39.5 Feb-05 13.5 39.8 Mar-05 13.5 40.0 Apr-05 13.5 40.5 May-05 13.5 40.1 Jun-05 13.5 40.6 Jul-05 13.4 40.6 Aug-05 13.4 40.8 Sep-05 13.5 40.7 Oct-05 13.5 40.7 Nov-05 13.6 40.8 Dec-05 14.0 40.8 Jan-05 13.1 39.1 Feb-05 13.8 40.7 Mar-05 13.9 40.9

Source:ISSP calculations Graph 3.3: Tax wedge on labor in

Montenegro (2001-2005)

35%37%39%41%43%45%47%49%51%53%55%

1998 1999 2000 2001 2002 2003 2004 2005


22


3.3. AVERAGE WAGE DYNAMICS BY ACTIVITY

In the first quarter of 2006 average wages have increased in annual terms in all activities with the exception of trade activity. Namely, in the first quarter of 2006 the average wages in wholesale and retail were 2.7% lower than they were in the first quarter of 2005.

As usual, the highest wages were recorded in the banking and finance sector. Average wages after taxes and contributions in the first quarter amounted to €450.64, which represents a 9.9% annual increase. The lowest average wages after taxes and contributions were recorded among hotel and restaurant workers, amounting to €125.16; however, as compared to the same period last year, the average wages in this area of activity actually recorded a 52% increase.

High annual growth rates of wages in the first quarter of 2006 are also recorded in the other communal and services activities (68.3%), in construction (47.2%), utilities (40.8%), and mining (26.6%).

The public services sector has also recorded a relatively high increase in average wages in the first three months of 2006 as compared to the same period in 2005. In addition to the influence of the new Law on wages of public servants and clerks (which on average has increased wages in administration) and the accumulated work experience, further explanation could be the changing structure of employees in administration. Most likely, the share of personnel who hold a university degree is increasing among the total number of employees; one reason for this is that some of the jobs that have in the past required lower education levels (such as typists) are no longer necessary because typically each employee has or can use a computer for him/herself.

In the education sector, employees’ wages have increased an average of 10% since January of 2006, when the new collective agreement for the education sector was finally accepted and signed by the teachers union and the Ministry of education. Namely, this increase is effectuated through higher wage coefficients that were initiated during the teachers’ strike at the end of 2002 and the beginning of 2003. At that time, the Ministry agreed to increase wages by 8%, with an agreement to increase an additional 10% later. Therefore, now in the new collective agreement, the wage coefficients of employees in education are 18% higher, while the actual increase in wages is only 10%. However, Monstat data does not

capture this increase.

9 The Monstat has not published the average wage for February, probably due to missing data, so the calculation of the average wage for the first quarter does not make sense. 10 A teacher is an employee with a college degree while a professor is an employee with a university degree.

Table 3.4. Average wages after taxes and contributions by activity

Average Q1-05 (in €

monthly)

Average Q1-06 (in €

monthly)

Change(in %)

Agriculture, forestry and water 143.49 171.26 19.4

Fisheries9 144.32 - - Mining 289.27 366.16 26.6

Manufacturing 176.00 200.86 14.1

Utilities 191.02 269.04 40.8

Construction 90.44 133.15 47.2

Wholesale and retail 137.27 133.59 -2.7

Hotels and restaurants 82.33 125.16 52.0

Transport, traffic and communications

263.14 281.79 7.1

Banking and finance 410.20 450.64 9.9

Mortgages, renting and business act. 175.91 199.00 13.1

Public administration and social insurance 229.64 261.33 13.8

Education 233.24 240.40 3.1

Health and social work 213.98 227.28 6.2

Other communal, social and service activities

99.22 167.02 68.3

Sources: Monstat and ISSP calculations

Table 3.5. Average wages and wages after taxes and contributions by activity

Average wage after taxes and contributions (in € monthly)

Average wage(in €

monthly)

Average teaching staff 299.94 467.21 Average non-teaching staff 115.92 163.67

Teacher10 with 15 years of experience 259.62 396.47

Professor with 15 years of experience 289.07 448.14

Teacher beginner 245.00 371.42 Professor beginner 278.00 413.30

Sources: Primary school from Niksic

Monet June 2006


However, the high growth rates of wages for certain activities cannot be explained by events in the economy (high increase in production, etc.). Probably, the high variability of wages recorded in the various activities actually depicts the quality of the data provided by the company in the sample. Additionally, these differences may indicate a decrease in the shadow economy because employers register higher wages due to a lower tax burden; this argument is supported by the fact that the highest growth rates of wages are recorded in the activities that are usually assessed to have a high share of shadow economy (trade, construction, hotels, and restaurants).


24


CHAPTER 4. PRICES

Table 4.1 Prices

CPI RPI PPI

2000=100 Monthly

change in %

Annual change in

% 2000=100

Monthly change in

%

Annual change in %

2000=100 Annual

change in %

2000 100.0 3.4 36.1 100.0 25.0 100.0 16.5 2001 120.2 1.8 21.8 123.0 8.6 23.1 114.4 14.5 2002 142.0 0.7 16.8 147.6 3.1 17.4 121.6 4.6 2003 151.6 0.50 6.8 159.4 0.5 7.7 127.8 2.9 2004 155.2 0.26 2.4 164.4 0.3 3.3 138.0 5.8 2005 161.6 0.20 104.1 173.8 0.2 5.5 140.8 2.1 2005-Q1 160.0 0.1 3.2 172.4 0.1 5.9 139.4 3.1 2005-Q2 161.9 0.5 4.1 173.7 0.28 5.2 140.3 0.9 2005-Q3 161.3 -0.1 4.8 174.0 0.05 3.6 141.4 1.6 2005-Q4 163.0 0.4 4.4 174.9 0.1 4.3 142. 2.6 2006-Q1 164.5 0.3 2.9 175.6 0.13 2.3 144.0 0.9 Jan-05 159.8 0.1 3.2 172.1 0.1 6.2 130.7 3.6 Feb-05 160.0 0.1 3.1 172.4 1.1 5.8 131.0 3.3 Mar-05 160.3 0.2 3.2 172.7 2.1 5.9 133.8 2.5 Apr-05 161.1 0.5 3.7 173.4 3.1 6.2 131.9 0.4 May-05 162.0 0.6 3.8 173.8 4.1 5.8 140.2 0.5 Jun-05 162.5 0.3 4.8 174.2 5.1 3.8 141.3 1.7 July-05 160.9 -1.0 4.6 173.8 6.1 3.5 141.3 1.5 Aug-05 161.2 0.2 4.7 173.9 7.1 3.5 141.4 1.3 Sep-05 161.8 0.4 5.2 174.4 8.1 3.7 141.6 2.1 Oct-05 162.3 0.3 5.2 174.8 0.2 3.3 141.6 2.1 Nov-05 163.3 0.6 5.7 174.9 0.1 3.4 141.7 2.2 Dec-05 163.5 0.2 2.5 175.1 0.1 1.8 143.0 3.5 Jan-06 164.1 0.3 2.9 175.5 0.2 2.6 143.1 3.1 Feb-06 164.5 0.3 2.9 175.7 0.1 2.3 143.7 -2.8 Mar-06 164.9 0.2 2.8 175.9 0.1 2.1 145.2 2.3

Source: Prices overview published by Statistical office of Montenegro, except the monthly rates for December 2004, which are ISSP calculations. o Table presents end-of-period values for monthly data and average period values for quarterly and annual data. o One-base index is calculated as a chain index according to Monstat indices based on respective

previous years. o Monthly and annual changes are based on data taken from Monstat publications except December 2004

monthly rates of change are calculated by ISSP 4. PRICES

Inflation in Montenegro in the first quarter of 2006 was 2.8%. The growth of prices of oil and oil derivatives in Montenegro pushed inflation up, as well as the rise of food product prices. A significant methodological change occurred in the structure of the consumer basket, which is the main indicator of inflation. The inflation prognosis for the following 12 months ranges from 3.3% to 4.6% in March 2007.

4.1. CONSUMER and RETAIL PRICE INDEX (CPI and RPI) CPI annual inflation11 has been at the level of 2.8% in the first quarter of 2006, which is lower than the annual inflation of 3.2% from the same quarter last year. The main cause for the price increase in the first quarter of 2006 was the change in the structure of the CPI basket, where the share of services and oil increased in total consumption and the share of food products was diminished.

11 End period inflation

Box. 1 Annual inflation in 12 countries of the euro – zone was 2.2% in March of 2002. Accommodation costs, transport, alcohol, and food have shown the most significant growth, while communications, recreation and culture, clothing and footwear have influenced the fall of the total index.

Monet June 2006


In the first quarter of 2006 both the annual and the average change were 2.8% and the average annual change was 2.9%, while the average monthly inflation was 0.3%:

CPI Inflation in 2006

Annual change12 Average change13 Average annual change14 Average monthly

change 15

Q1 2.8 2.8 2.9 0.3

Source: Statistic office of Montenegro Calculation: ISSP Annual inflation in January and February of 2006 were 2.9%, while in March it was 2.8%. CPI monthly changes in the first quarter of 2006 were: 0.3% in January and February and 0.2% in March.

Graph 4.1. CPI Inflation

-1

0

1

2

3

4

5

6

7

8

9

Apr-

03

Jun-

03

Aug-

03

Oct

-03

Dec

-03

Feb-

04

Apr-

04

Jun-

04

Aug-

04

Oct

-04

Dec

-04

Feb-

05

Apr-

05

Jun-

05

Aug-

05

Oct

-05

Dec

-05

Feb-

06

%

Monthly Annual

Source: Statistic office of Montenegro Calculation: ISSP

Box. 2 The Statistical office of Montenegro (MONSTAT) adopted a new weightening system of the CPI basket in January 2006. In the meantime, the weights were changed in 2003 and 2004 on the basis of price increases, but it did not result in a significant change in the structure. The new weight system, as explained by MONSTAT, is based on the quantities sold in the retail sector and the share of services based on MONSTAT data of rendered services, the household budget survey, and respective systems in the region. In the future, application of the household budget survey based on European standards is expected. The new structure of the consumer basket includes 70 new products16 and the share of individual products / services has been changed in the total consumer basket. The table shows the old and new share of 7 basic index subgroups and the percentages of their changes:

12 “Annual change” is a change of the index in the current month related to the same month of the last year. This way of measuring inflation is known as “end period inflation”. The ISSP uses the annual change of CPI as a main indicator of inflation. CPI “December on December” is inflation in a specific year 13 “Average change” or “Average on average” represents the change of the index for a specific period of the current year related to the average of the index for the same period of the last year. 14 “Average annual change” represents an arithmetic mean of annual changes of the index in an observed period. 15 “Average monthly change” is calculated by applying a geometric mean for a month in a specific period (quartile or year).


26


Name of the group Share of index subgroups in the total index in % (up to

2005)

Share of index subgroups in the total index in % (from

2005) Weight change in %

1. Food 58.61 50.46 -13.9 2. Tobacco and beverages 7.71 6.94 -10.0 3. Clothing and footwear 8.01 8.45 5.5 4. Accommodation 10.51 12.59 19.8 5. Hygiene and personal care 5.24 7.12 35.9 6. Education and culture 4.2 4.6 9.5

7. Transportation vehicles, transportation and telecommunication services

5.72 9.84 72.0

Total 100 100

Further disaggregating of the CPI leads to a more detailed overview of the share of specific subgroups in the total CPI and the change of that share related to 2004 and 2005.

Name of the group Share of index subgroups in the total index in % (up

to 2005)

Share of index subgroups in the total index in %

(from 2005) Weight change in %

1. Poultry products 8.4 7.8 -7.7 2. Fresh and processed vegetables 5.9 6.3 7.3 3. Fresh and processed fruits 5.1 4.8 -7.0 4. Fresh and processed meat 18.3 13.5 -26.6 5. Fresh and processed fish 1.2 1.2 -1.7 6. Fresh and processed milk 8.8 7.5 -15.1 7. Fresh eggs 2.0 1.4 -26.9 8. Fat 3.3 3.0 -10.6 9. Other food products 5.6 5.2 -8.2 10. Beverages 2.9 3.2 9.9 11. Tobacco 4.8 3.7 -22.2 12. Clothing and services related to clothing 4.4 5.2 17.3 13. Footwear and services related to footwear 3.6 3.2 -9.2 14. Accommodation 2.2 2.5 13.3 15. Heating and lighting 6.7 7.4 10.5 16. Accommodation accessories 1.7 2.7 66.1 17. Hygiene accessories 3.9 4.3 11.1 18. Medicines 0.5 1.9 260.4 19. Health care services 0.9 0.9 8.2 20. Education accessories 2.8 3.1 11.1 21. Services for education and culture 1.4 1.5 6.4 22. Transportation vehicles 0.2 0.8 338.9 23. Liquid fuels and lubricants 1.8 4.0 118.6 24. Vehicle maintenance accessories 0.4 0.9 127.5 25. Traffic and postal and telecom services 3.3 4.1 25.1

As you can see in the upper tables, there has been a significant rise in the share of fuel, electric energy, medicines, and transportation vehicles, so that the changes of those products will have a great impact on total inflation. On the other hand the share of food products and tobacco has been diminished. In summary, the share of services has risen from 8.2% to 10.1%, goods excluding food, beverages and tobacco rose from 24.9% to 32.5%, and food, tobacco, and beverages has diminished from 66.9% to 57.4%. With the new weight system the consumer basket is closer to the real picture of consumption within the average Montenegrin household; however, it still does not take into account products that represent the expenditure of households, thereby affecting inflation. Also, the consumer basket still takes into account only the prices of domestic products, although the Montenegrin economy is mostly import oriented (except import cigarettes), and the reference to transport vehicles is still represented by the price of a Yugo. The effect of prices of some kinds of services is still not monitored: tourist, catering, internet and GSM services.

Retail prices have reached an annual inflation of 2.1% in the first quarter of 2006. This is significantly lower than the annual inflation of 5.9% in the same quarter last year. Annual

16 Food: corn flour, cornflakes, black flour bread, wheat bread, cheese pies, leek, frozen beans, sour paprika, baby food, ketchup, mandarins, grapefruit, kiwi, frozen fish, frozen hake, cream, olive oil, mayonnaise, chewing gum, mineral water 1.5l, import cigarettes, nes cafe. Tobacco and beverages: Coca cola 2l, mineral water 1.5l, import cigarettes Clothing and footwear: children jeans jacket, child sweater, baby bunny, tie, female sleeping gown, children socks, female hoola hups winter Residence: semidispersed color, wall tapestry (paper) ceramic tiling, wooden floor tiling, lighter, tablecloth, 100% wool carpet, wine glass, fire resistant bowl, quartz alarm clock, air-condition device, dish washer, cell phone, fix phone, personal computer Hygiene and personal care: detergent for machine washing, paper diapers, mini pads, paper handkerchiefs, hair dryer, beyipleks, oligovit, pentrexil, bactrim, penicillin, nose drops. Education and culture: filling for 0.5 pen, VCR, DVD, photo camera, film for photo camera, empty CD, empty video cassette, A4 photocopying, video cassette renting, DVD renting Traffic: motor gas MB 98, motor gas BMB 95, eco diesel. Products that are not in the consumer basket, or they are weighted by a weight 0 are: bread from flour tyoe 850, mineral water 1l, 6 person tablecloths and accessories, motor gas of 95 octane, motor gas of 86 octane

Monet June 2006


inflation in the months of the first quarter 2006 were 2.6% in January, 2.1% in February and March, while monthly inflation was at 0.2% in January and 0.1% in February and March. Average inflation in the first quarter of 2006 was 1.9% and the average annual infaltion was 2.3%, while the average monthly inflation was 0.1%. Analyzing the main indicators of inflation in the fourth quarter, we have reached the following results.

IMC 2006

Annual change Average change Average annual change Average monthly change

Q1 2.1 1.9 2.3 0.1

Source: Statistic office of Montenegro Calculation: ISSP

Graph 4.2 RPI Inflation

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Source: Statistic office of Montenegro - Calculation: ISSP

4.1.2. Disaggregated price changes

Table 4.2. Annual changes of disaggregated components of PPI

Product or service group

Total index Food

Tobacco and

beverages

Clothing and footwear

Accommodation

Hygiene and

personal care

Education and culture

Traffic vehicles and

transport and

communication services

Weights in 2004 100 50.46 6.94 8.45 12.59 7.12 4.6 9.84

2004.

Jan 3.17 -2.08 1.04 3.98 0.74 1.28 1.39 68.62 Feb 3.11 -2.13 1.19 3.60 0.71 1.36 0.26 71.05 Mar 3.22 -1.91 1.34 3.17 0.69 1.52 0.34 71.50 Apr 3.67 -1.54 4.34 2.29 0.67 1.59 0.35 72.76 May 3.85 -0.81 5.29 2.64 0.62 0.82 0.31 67.02 Jun 4.80 0.78 6.03 1.88 0.64 0.47 0.33 66.86 Jul 4.56 -0.05 6.45 1.78 0.64 0.47 0.43 69.50 Aug 4.72 0.01 6.48 1.48 0.74 0.44 0.44 68.05 Sep 5.15 0.63 6.52 1.55 0.56 0.40 0.74 67.38 Oct 5.16 0.89 6.43 1.45 0.26 0.42 0.75 65.71 Nov 5.69 2.24 6.43 0.93 0.48 0.37 0.85 63.99 Dec 2.45 2.54 6.59 0.98 0.48 0.40 0.84 4.69

2006.

Jan 2.45 2.54 6.59 0.98 0.48 0.40 0.84 8.85 Feb 2.88 3.15 3.99 0.89 0.36 0.38 0.60 6.94 Mar 2.89 3.62 2.94 0.95 0.42 0.57 0.49 5.06

Source: Statistic office of Montenegro - Calculation: ISSP


28


The average annual inflation in the first quarter of 2006 was 2.9%. Analyzing the relative price changes of seven basic groups of the disaggregated CPI, we come to the conclusion that the inflationary effect came from the groups of Traffic vehicles and transport and communication services, which had an average annual inflation of 7.0%, food with inflation of 3.6%, and tobacco and beverages with inflation of 3.2%. Average annual inflation among other groups of the disaggregated CPI was lower than 1%, and therefore had a deflationary effect on the total index in the first quarter of 2006: clothing and footwear 0.95%, Hygiene and personal care 0.6%, education 0.5%, and accommodation 0.4%. Regarding annual inflation at the end of the period, there was also growth of some sub-indices, which affects growth of the total index in March: Traffic vehicles, transport and communication services (5.1%), food (3.6%), and Tobacco and beverages (2.9%), while other sub-indices had a deflationary effect. According to the detailed sub-indices in December of 2005, the most significant price changes were the following: Prices of food (50.5%) products have risen sharply on an annual level, acting as a great inflationary effect in all three months of the first quarter of 2006, even with their lower share in the CPI consumer basket. High annual inflation was especially registered for fresh and processed fruit (17.8%), eggs (4.4%), and wheat products (3.9%), while the price of fish has continued to have a deflationary effect, with an annual inflation rate of –4.3%. High inflation with food products was a result of the tax policy, the increase of the VAT rate for basic food products from 0% to 7%, as well as the direct influence of the increased fuel price for transport.

Prices of tobacco products and beverages (6.9%) have experienced high inflation due to the annual growth rate of beverage prices of 5.3%, while tobacco prices have had an annual inflation rate of 0.2%. Prices of clothes and footwear (8.5%) have had an even lower inflation rate this quarter than they did last quarter. Thus, the annual inflation rate of footwear was 0.5%, and of clothes 1%. Low annual changes of prices were monitored by the index subgroup accommodation (12.6%), where the highest annual change was for the group heating and lighting with 0.5%. Accordingly, in the subgroup hygiene and personal care (7.1%) no group had inflation that was higher than 0.5% (hygiene accessories). In education and culture (4.6%), the highest annual change of 1.4% is due to the rise of education service costs. Prices of traffic vehicles transport and communication services (9.8%) have had the highest increase in their weight in the system. With that, the constant rise of fuel prices in the first quarter of 2006 (9.5%) had a more significant influence on the total index. By monitoring the changes of fuel prices, services for vehicle maintenance have also had high annual inflation (16.8%). Traffic and communication service prices had no changes. In comparison to the annual rates of components in the Eurostat consumer basket we can observe similar trends of price changes in December of 2005. The components with the highest inflation of the total CPI in the euro zone were: accommodation (5.1%), transport (4.5%), and tobacco and beverages (2.7%), while the lowest annual rates were for communications (-2.8%), recreation and culture (0.1%), and clothing (0.3%)17.

17 Www.eurostat.org. Harmonized Indices of Consumer Prices (HICPs) are harmonized inflation figures required under Article 121 of the Treaty of Amsterdam (109j of the Treaty on European Union). They are designed for international comparison of consumer

Monet June 2006


According to the three analyzed indices in December of 2005, the highest annual inflation in Montenegro was for food, tobacco, and beverages (2.9%). Goods without tobacco and beverages had inflation of 1.%, while services were 1.5%. 4.1.3. COST OF THE FOOD CONSUMER BASKET (FCB)18 Table 4.2 Cost of the food basket in Montenegro (in €)

Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec 2005 240.22 241.54 241.09 241.99 246.21 267.34 259.32 259.96 261.10 262.37 263.06 263.13

2006 264.47 266.36 266.73

Source: Monstat Cost of the Food consumer basket has registered annual inflation of 10.6% in the first quarter of 2006, with an increase of 16.8 percentage points since March of 2006. As in the previous months, the trend of the FCB cost followed the trend of the food index in the total consumer basket. Fresh fruit and vegetables had the most significant upward impact. Monthly changes in January, February, and March were 0.5%, 0.7%, and 0.1%, respectively.

Graph 4.4.Cost of FCB (in EUR)

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price inflation. The focus is on quality and comparability among the indices of different countries as well as on their relative movements.

Price changes as measured by the HICPs, the Monetary Union Index of Consumer Prices (MUICP), the European Index of Consumer Prices (EICP3) and the European Economic Area Index of Consumer Prices (EEAICP) are used as measures of inflation in the Member States, in the euro-zone, in the European Union, and in the European Economic Area. 18 The food consumer basket consists of a group of basic food products in the quantities adequate for a four-member family. The concept of the basket was developed following the guidelines of the EU to approximate the cost of basic food needs for a four-member family. Thus, it allows for easy comparisons between countries.

raph 4.3. Food consumer basket (annual change)

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30


4.2. PRODUCERS PRICE 4.2.1. PPI Inflation After the growth trend in the second half of 2005, producers and wholesale prices have registered lower annual inflation of 2.3% in the first quarter of 2006. Compared to the previous year, same quarter inflation was on a similar level. Oil represents a significant input for production and wholesale. Thus, PPI is very sensitive to changes in the price of oil. The average change and average annual change of PPI were 3.2% and 0.9% respectively in the first quarter of 2006, while the average monthly change was 0.5%. In the first three months of 2006 the annual change in PPI was 3.1%, -2.8%, and 2.3% in January, February and March, respectively. Monthly inflation in the same period was: 0.1% in January, 0.4% in February, and 1% in March.

Graph 4.5. PPI inflation

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Source: Montstat 4.2.2 PPI DISAGGREGATED CHANGES

Electricity, gas and water 0

PPI 2.3

Construction materials 7.2

Textile and cloth production 23.4

The inflationary effect of PPI in the first quarter of 2006 came from textile and cloth production expenditures, construction materials, mining and stone extraction, as well as from the processing industries production of electricity and construction materials, while the deflationary impact originated from the chemical products industry. Annual inflation of the sub-indices review in the first quarter of 2006 follows. Mining and stone extraction registered a high 5.1% annual inflation, mostly due to the high annual inflation of oil, as oil product prices are one of the main costs in this kind of production industry.

Monet June 2006


Processing industry prices experienced a decrease of 2.4% in their annual rate. Analysis of the observed sub-indices showed a different effect on the processing industry index as was shown on total PPI: o Food, tobacco and beverage production showed a decreasing trend to 0.4% o Chemical products production continued its negative growth of prices to -17% o Textile production, after a long period of unchanged prices, experienced a 23% monthly

and annual inflation rate in February and preserved that level in March as well. Construction materials, after decreasing in February to -5.6%, it increased in March to 6.2% and 7.2%, monthly and annually, respectively. Electricity, gas and water prices have not changed on an annual basis since April 2004. 4.3 INFLATION MEASURED BY DIFFERENT INDICATORS: PPI, RPI AND CPI Graph 4.6 shows the annual rates of change of consumer, retailer, and producer price indices. In the first quarter of 2006, the annual change of the consumer and retailer price indices experienced an increase while the producer price indices experienced a decrease in February and then increased in March. Oil and the price of oil products continue to have significant influence over price on both the producer and retailer price indices. Food, tobacco, and beverage prices in the retail sector had faster growth in the first quarter of 2006 than the same products in the producers’ sector. The growth is due to a greater and more significant influence of fresh fruit and vegetable seasonal price changes as compared to the prices of processed foods that are registered by the processing industry. Although prices in the textile industry had significantly risen in Q1 of 2006, the retail sector has not recorded a significant increase, but on the contrary, it shows a decreasing trend. It is possible that the effects of this sub-indices inflation will be visible through a delayed future influence. According to the negative rates for prices of chemical products, retail prices of hygiene and personal care products experienced a decreasing trend as well. Electricity prices remained the same in the producers sector as in the retail sector.

Graph 4.6. PPI, RPI i CPI - annual changes

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Source: Monstat


32


4.4. FORECASTS An inflation forecast for the first quarter of 2006 was 2.8% according to an optimistic scenario, and as it turns out, that was the actual inflation. The pessimistic scenario included a growth in the price of electricity, which didn’t happen in March. The next 12 months, we forecast an increase in the price of oil and oil products as well as electricity; these increases are expected according to both scenarios, optimistic and pessimistic. As we wrote in the previous MONET issue, oil and energy prices have a direct impact, through household consumption, and an indirect impact, through production and service costs of producers and distributors. The optimistic scenario for inflationary developments in the next 12 months (April 2006 – March 2007) assumes: o Continuation of the CPI dynamics as in the next 12 months o Projected monthly increase of fuel price by 0.20%, and according to that, a monthly

increase of outlay for owning a car by 0.04%. o Monthly increase of electricity price by 7% in November of 2006 The pessimistic scenario of inflationary developments in the next 12 months (April 2006 – March 2007) assumes: o Consumer prices increase a bit faster compared to the optimistic forecast dynamic o Projected monthly increase of fuel price by 0.25%, and according to that, a monthly

increase of outlay for owning a car by 0.09%. o Increase of Electricity price by 15% in October of 2006. The resulting projected inflation in the next 12 months ranges from 3.3% to 4.6%, as shown in Graph 4.11. According to the optimistic scenario, the inflation rate is projected to be: 2.9% in Q2 2006, 2.7% in Q3 2006, 3.4% in Q4 2006, and 3.3% in Q1 2007. According to the pessimistic scenario, the inflation rate is projected to be: 3.0% in Q2 2006, 2.9% in Q3 2006, 4.4% in Q4 2006, and 4.6% in Q1 2007.

Graph 4.7. Twelve months inflation forecast

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Source: Monstat

Monet June 2006


CHAPTER 5. BUDGET

5.1 CENTRAL BUDGET IN THE FIRST QUARTER OF 2006 5.1.1 Budget balance and financing In the first quarter of 2006, the central budget ran a deficit in the amount of €5.50 million. According to ISSP projections of the quarter GDP, the share of deficit in GDP accounted for 1.3%. Accumulated funds for deficit financing were negative and amounted to €5.71 million. The reason for that lies in the fact that in the first quarter of 2006 the GoM repaid €6.63 million of debt based on issued securities, which is 10.7% more than it repaid on debt in the same period last year. Out of that amount, about 90% was paid to residents and the rest to non-residents. At the same time, the first quarter was characterized by a small amount of loans taken, reaching only €0.28 million as compared to 2005 when inflows in the republic budget on this basis accounted for €6.70 million19. In the first three months of 2006, privatization revenues were at the level of €0.65 million, representing 9.3% of the annual plan of privatization receipts20.

Graph 5.1. Budget deficit in the first quarter of 2006

budget revenues95%

deficit5%

Source: Ministry of Finance, ISSP calculations

19 Loans were taken from foreign sources. 20 In the first quarter of 2006, privatization of some of the big systems and enterprises in Montenegro did not occur. Higher privatization cycle is expected in the III and IV quarter of the current year.

Last year’s increasing trend of payment of taxes, contributions, and other levies in Montenegro continued in the beginning of this year as well. The first quarter of 2006, undoubtedly was marked by a strong inflow of VAT revenues amounting to €51.03 million, which is 53% higher than the same period of 2005. The share of this tax category was 49.6%. The high VAT revenue is certainly a positive indicator of both the current fiscal policy and tax policy that Montenegro follows; but, at the same time, the Government has to be cautious with respect to consumption and allocation of revenues that exceed the planned amounts. The reason for this is that higher revenues always have an automatic impact on increasing demand on the expenditures side of the budget. According to that, VAT revenues should not stimulate additional consumption and should be used as a means of decreasing budget financing with the deficit. Therefore, it is necessary to “set aside” a fund for infrastructure projects’ financing, which are necessary in Montenegro for accelerating the important investment cycle or for other alternative uses (financing the pension deficit, reduction of the public debt, etc.). Bearing in mind the deficit of infrastructure objects (modern roads, canalization, schools, etc.), financing infrastructure projects from real sources (instead of domestic and foreign loans) is very important. In any event, accumulated VAT revenue is important for the creation of a stable fiscal reserve for the coming years. Hence, we recommend to further restrict expenditures within the budget and tp follow a conservative fiscal policy based on the fiscal adjustment on the expenditures side.


34


Together with the negative funds aimed at deficit financing, the deficit influenced a reduction of deposits (financial assets) of the republic budget in the amount of €11.20 million. In the analyzed period, the republic budget received €0.004 million of grants.

5.1.1. Quarterly projection of the budget balance until the end of 2006

Basic assumptions in the projection of the budget balance until the end of this year in both of the developed scenarios are the following: o outturn of revenues and expenditures and accumulated deficit in the first quarter of 2006; o projected GDP for 2006 in the amount of €1,786.5 million (ISSP calculations); o GDP quarterly projection, which was done on the basis of the assumptions defined within

the Macroeconomic model for Montenegro (ISSP); o similar dynamics of the movement of revenues and expenditures within the Montenegrin

budget as in recent years (seasonal character, low revenues at the beginning of the year, high expenditures at the end of the year, etc.)21;

o annual plan of budget revenues and expenditures for 2006.; o arrears and perspective liabilities of the republic budget and efficiency with regards to all

tax categories payments.

I) Scenario I

Assumptions of scenario I are the following: (1) outturn in the first quarter of 2006; (2) revenues and expenditures for the remaining three quarters according to the budget plan for 2006; (3) increase of revenues in the remaining three quarters in the interval from 1 to 3% compared to last year’s execution, while, at the same time, maintaining the trend of expenditures movement from previous years.

Scenario I projects the deficit of the central budget at the end of the year to be €19.30

million or 1.08% of projected GDP. This projection points to a negligable increase of 0.07 percentage points of the deficit share in GDP in comparison with the projected deficit at the beginning of the year (€18.07 million). Projection outturn indicates that in addition to actual deficit in quarter I, a deficit in the amount of €23.39 million will also be run in quarter IV, while surpluses in the amounts of €1.78 and €7.80 million, respectively, will mark quarters II and III, respectively.

Graph 5.2 Quarterly share of the nominal budget balance in GDP- scenario I

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Source: ISSP calculations

21 Impact of the tourism season influences the highest revenues during the III quarter. Characteristic of the expenditures is their increase in the last quarter as a result of payment of wages and salaries and other remunerations for employees for the month of January of the perspective fiscal year.

Monet June 2006


Scenario I points to a stronger increase of budget revenues than budget expenditures in quarters II and III due to expectations of a successful tourist season, greater mobility of people, goods, services, and capital on the Montenegrin market in that period and, consequently, higher payment of taxes, contributions, and other duties imposed by the state. On the other hand, stronger growth of expenditures will occur in the last quarter due to the higher current expenditures of the republic budget and social transfers that are made to settle the defined social liabilities to the Montenegrin people. Regardless of that, scenario I still predicts a fairly high level of budget revenues in Q4, which does indicate a positive tendency. Planned investment spending has a linear trend during the year. II) Scenario II Assumptions of scenario II are the following: (1) outturn in the first quarter of 2006; (2) revenues and expenditures of the budget in the remaining three quarters as according to the budget plan for 2006; (3) revenues and expenditures trends in the remaining three quarters in accordance with the previous years, with the assumption that expenditures will grow by about 0.5% in quarters III and IV as compared to the outturn in the previous years. Results of scenario II point to a deficit in the amount of €26.15 million or 1.46% of

projected GDP at the end of 2006. The nominal amount of the projected deficit is 14% lower than the actual deficit at the end of 2005. In accordance with this scenario, surplus in the amount of €3.43 and €0.68 million, respectively, is expected in quarters II and III, respectively; while in quarter IV, the budget balance will be negative and will amount to €24.78 million. As in the previous scenario, this scenario indicates the biggest deficit in quarter IV (35% higher than the deficit in scenario I).

Graph 5.3 Quarterly share of the nominal budget balance in GDP - scenario II

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Realization of this scenario would result in an increased deficit by about €8.0 million as compared with the projected deficit at the beginning of the year. At the same time, that means that a negative fiscal adjustment of about 0.3 percentage points would occur in the state budget. Consequently, it is suggested that one more cautiously pursues a budget expenditures policy in the remaining three quarters of 2006 in an attempt to reach a deficit at the end of the year that is approximately equal to the projected deficit at the beginning of 2006.


36


Expectations about higher inflow from privatization in quarters III and IV of 2006 allow for financing of the deficit and regular servicing of budgetary liabilities towards all budgetary users. The basis in the development of this scenario was both the high revenues and expenditures in Q1 of the current year. High expenditures in the first three months determined their level in the remaining three quarters. Regardless of the increase of expenditures, the positive tendency has expectations about their higher levels being primarily related to investment consumption, while current spending is forecast at a level that is negligibly higher than planned.

ISSP projection in this scenario also indicates that a restriction of budget expenditures in quarters II and III of only 0.01 percentage points would lead to a decrease in the deficit, bringing it to €23.27 million or 1.3% of GDP, making it possible for Montenegro to have a sustainable fiscal position at the end of 2006. 5.1.2 Total revenues and grants At the end of March of 2006, total revenues of the central budget amounted to €102.88 million, which is 38.2% higher than last year and, at the same time, represents 21.2% more than the planned amount for 2006. Out of that amount, €94.33 million is related to tax revenues, while the remaining 8.3% were non-tax and capital revenues.

Graph 5.4 Structure of budget revenues in the first quarter of 2006.

tax revenues92%

capital revenues0% grants

0%non-tax revenues

8%

Source: Ministry of Finance, ISSP calculations 5.1.2.1 Tax revenues

The overall payment of taxes in the central budget was 35.1% higher as compared to the same period last year and amounted to €94.33 million. In large part, this is due to the fact that in the observed period economic activity has risen and also weather conditions were much more favorable than in 2005 -- roads were passable allowing for greater mobility of people, and goods and services provided were realized (these were the main reasons for the lack of tax revenues in the first quarter of 2005). All together, these things made the work of tax officers much easier. INDIRECT TAXES Revenue from value added tax amounted to €51.03 million, representing 49.6% and

54.1% of total and tax revenues, respectively. As compared with the same period of 2005,

Monet June 2006


VAT revenues were 57.9% higher. A significantly high proportion of VAT revenue is a direct consequence of increased economic activity, decreased scope of the gray economy with respect to production and turnover of goods and services in Montenegro, and increased efficiency in the work of tax officers. Additionally, the increase in VAT revenue is a result of the introduction of the reduced rate, which was effective on January 1st of 200622. Q1 VAT outturn represents 23.7% of the annual plan. The first quarter of 2006 once again confirmed the fact that VAT, since its introduction, represents the most important mechanism of preserving budget liquidity and stability, and, at the same time, is an instrument for reducing the level of gray economy in the state23.

Table 5.1. Tax structure in the first quarter of 2005 and 2006 (€ millions)

Source: Ministry of Finance, ISSP calculations Excises are the second largest revenue category amounting to €13.95 million at the end of

March of 2006. Their outturn was 13.9% higher than last year and represents 18% of the annual plan.

At the end of March of 2006, customs revenues24 amounted to €10.01 million, which

represents 25.1% and 9.7% of the annual plan of customs payment and total revenues, respectively.

Other taxes amounted to €0.91 million, which is 1% of tax revenues.

DIRECT TAXES Personal income is the third largest revenue category within the Montenegrin budget in

the analyzed period. PIT revenues amounted to €13.77 million, which represents 19.6% of planned revenue; and at the same time, it is 21.8% higher than last year’s amount.

Revenues from corporate income tax amounted to €3.77 million, which is 1.6% lower

than the same period last year. Although implementation of the reduced proportional rate of 9% is still in its early stage (rate was implemented on January 1st of 2006), a negligible decrease of revenues on this basis indicates that the change of rate will bring a positive trend to the Montenegrin public finance system and also brings positive expectations for higher revenues on this basis in the future. Expectations about the 9% rate are related to its impact on the reduction of the scope of the gray economy.

22 The introduction of the reduced rate on goods earlier freed from taxation had an effect on the increase of VAT revenues due to the fact that with this legal change, producers of these goods may calculate exit VAT and, thus, have a right to the refund of entry VAT, which was not the case previously. By giving this opportunity, the introduction of a 7% rate did not provide an incentive for producers to both avoid taxation payment and increase prices of their own goods. 23 Since April of 2003, when VAT was introduced, the tax administration recieved about 2.64 thousand request for VAT refunds, out of which about 96.7% were settled. On the basis of these requests, about €109.0 million was refunded to tax payers, with reallocation of one-tenth of that amount. For another 29 requests, inspection checks are needed, after which they will be partially or totally adopted or rejected. Payers have the right to a refund if they pay more VAT on a monthly basis for purchased goods and services than the VAT they charge when selling their goods, after making the declaration on their monthly tax registration. 24 In previous years, the budget had revenues from transit fees, which represented part of the tax on the international trade and transactions. Since 2006, according to the legal decision, this type of revenue is not paid into the budget any more.

Q1 of 2005 Q1 of 2006 index (%) plan for 2006 % of plan

Indirect taxes 52.16 75.9 45.5 335.73 22.61 VAT 32.31 51.03 57.9 215.12 23.72 Excises 12.25 13.95 13.9 77.55 17.99 Customs 7.01 10.01 42.8 39.72 25.20 Other taxes 0.59 0.91 54.2 3.34 27.25 Direct taxes 15.52 18.43 18.8 88.60 20.80 Personal income tax 11.31 13.77 21.8 70.30 19.59 Corporate income tax 3.83 3.77 -1.6 16.04 23.50 Estate and real estate tax 0.38 0.89 134.2 2.26 39.38 TOTAL 67.68 94.33 39.4 424.33 22.23


38


Estate tax amounted to €0.88 million and was 134.2% higher than the outcome in the

same period of 2005. Analysis of the composition of tax revenues in the first quarter of 2006 as compared to the same period of 2005 notes a trend of an increasing share of revenues from indirect taxes and a simultaneous decreasing share of revenues from direct taxes in total tax revenues. This approach, which has been present for the last couple of years in the Montenegrin public finance system, is shown on the following graph.

Graph 5.5. Share of direct and indirect taxes in tax revenues in the first quarters of 2005 and 2006

0

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Q1 of 2005 Q1 of 2006

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Source: Ministry of Finance, ISSP calculations 5.1.2.2. Other revenues Non-tax revenues amounted to €8.54 million and were 86.3% higher than last year. They are comprised of: fees (administrative, courts and residential) with a share of 31.0% in non-tax revenues totaling €2.65 million, compensations (for public goods usage, for natural goods usage, ecological compensation, compensation for organization of games of chance, compensation for roads, and other compensation) in the amount of €2.74 million, and other revenues (money fines and repossessed property interests, own activity revenues and payment of tax claims from the previous years) in the amount of €1.00 million. Capital revenues amounted to €0.01 million and were 76% lower than the same period of last year. In the analyzed period, the republic budget received €0.004 million of grants.

Box 1. Completed three-year arrangement with IMF In February, the IMF Board of Directors made a positive decision on completing a three-year financial arrangement with the Union of Serbia and Montenegro as a condition for the Paris Club of creditors to “write off” an additional 15%, or about $€700 million, of debt. On the basis of this decision, about $26 million of Montenegrin debt was written off in March, thus making the basis for a “new favorable borrowing aimed at infrastrucure construction”. The three-year arrangement from May of 2002 amounted to $937 million. Serbia was taking loans to preserve currency stability, for Montenegro uses the euro as their official currency. However, if the decision was not positive, that would be a negative signal for potential investors.

Monet June 2006


5.1.2.3 Quarterly projection of the most important tax categories outturn until the end of 2006 Quarterly projection of tax revenues until the end of 2006 is comprised of the most important taxes within the central budget: VAT, excises, personal income tax, and customs, which altogether have a share of over 90% in total tax revenues. As a basic assumption, the projection took the following: o outturn of these tax categories in quarter I of 2006; o stable dynamics of tax revenues in the Montenegrin budget as in the previous years

(seasonal character, cyclic movement of some taxes, trend etc.); o annual plan of budget revenues and expenditures for 2006.; o efficiency with respect to the payment of all tax categories. Table 5.2 Quarterly distribution of the most important tax categories in 2006

Q1 Q2 Q3 Q4 Total-projection Plan for 2006 Deviation from

plan (%)

VAT 51.03 72.73 95.61 80.91 300.28 215.12 39.59 Excises 13.95 19.11 23.90 19.35 76.31 77.55 -1.60 Personal income tax 13.77 17.70 18.97 20.13 70.57 70.30 0.38

Customs 10.01 9.32 10.96 9.44 39.73 39.72 0.03

Source: ISSP calculations Table 5.2 shows that ISSP projects that VAT revenues will exceed the plan by almost 40%,

or about €85.4 million, which would (in the case of realization) represent a significant inflow of revenues in 2006. This VAT inflow would create the possibility of making some corrections to the current tax rates in the Montenegrin tax system because it would allow for financing of the deficit, which a reduction of the tax rate may do in the short term.

According to the ISSP projection, excise revenues at the end of 2006 will be about 1.6%

lower than what was planned. PIT and customs revenues should negligibly exceed the determined annual plan.

Graph 5.6 Quarterly distribution of the most important tax categories in 2006

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VAT excises PIT customs



40


Graph 5.6 clearly shows the importance of VAT revenues for the republic budget. In other words, the estimated sum of revenues on the basis of the other three analyzed tax categories accounts for only 62.1% and 86.7% of the projected and planned VAT revenue in 2006, respectively. 5.1.3 Total expenditures and net lending Total expenditures (including net lending) amounted to €108.38 million and were 52.7% higher than the same period of last year. Non-interest spending and paid interest amounted to €99.54 and €4.00 million, respectively, a share of 95.5% of current spending in the total budget spending. Capital expenditures and net lending had a share of 3.0% and 1.5% in total expenditures, respectively. If transfers are excluded from total expenditures, the estimation indicates that in the analyzed period €73.68 million, or 68.0% of expenditures, were current spending and investments, while the remaining €34.70 million represented redistrubution (transfers). In comparison with the same period of last year when consumption and investment represented 62.9% of total expenditures and transfers had a share of 37.1% in total expenditures, it is clear that the redistributive role of the state is reduced by about 0.5 percentage points. The structure of budget expenditures is shown in the following graph.

Graph 5.7 Structure of budget expenditures in quarter I of 2006.

consumption64%

transfers32%

net lending1%

investments3%


Wages, salaries and other remunerations for public sector employees amounted to

€43.34 million and were 45.9% higher than the same period of last year. The share of this expenditures category in total expenditures was 31.7%. Gross wages and salaries and contributions paid by employers amounted to €31.93 million, out of which 68.5% or €21.86 million was related to net salaries, while taxes on salaries, contributions and municipal surtax accounted for €3.07, €7.50, and €0.50 million, respectively. Other remunerations were 96.8% higher as compared with the same period of 2005 and amounted to €1.42 million.

Expenditures on goods and services had a share of 10.17% in total expenditures and

amounted to €11.02 million. Expenditures on goods and services amounted to €7.96 million, while the remaining 27.8% or €3.07 million was related to the current maintenance of the public infrastructure, buildings, and equipment.

Monet June 2006


Social insurance and social security transfers cumulatively amounted to €34.70

million and had a share of 32.0% in total expenditures.

The greatest share in this category was had by social insurance transfers in the amount of €22.50 million, or 64.8%, while social security transfers amounted to €12.20 million. The Pension Fund received the most in social insurance transfers, amounting to €13.14 million (19.0% of the annual plan of transfers to this social fund). The Health Insurance Fund and Employment Fund received transfers in the amount of €1.18 and €1.39 million respectively, which represents 16.60% and 25.0% of the annual plan, respectively. Public institutions, NGOs, political parties and associations, individuals, and municipalities received transfers in the following amounts: €3.87, €0.58, €2.16, and €0.19 million, respectively. Social security transfers for vulnerable casts, which include child allowances, veteran benefits, family material support, maternity leave, other person care, pupils kitchen, foster care, and other social security benefits cumulatively amounted to €8.24 million. Severance pay for redundant labor was at the level of €0.81 million.

Subsidies (for production and services provided) amounted to €1.01 million, or 0.9% of total expenditures.

At the end of March of 2006, rent, other expenditures25 and repayment of liabilities from previous years amounted to: €0.70, €0.22, and €7.57 million, respectively, which cumulatively amounted to €8.49 million, or 7.8% of total expenditures.

Reserves amounted to €2.08 million and were totally related to the current budgetary reserve because in the analyzed period no funds for the permanent budgetary reserve were released.

Interest amounted to €4.01 million and was 6.7% higher than interest payments in the same period of 2005. This increased amount of interest in the amount of €3.74 million was paid to non-residents, while residents received €0.27 million.

Capital expenditures amounted to €3.25 million and had a share of 3.0% in total expenditures. In comparison with the same period of last year, they were about 2.5 times higher. The greatest share of capital expenditures was related to expenditures on construction of buildings and investment maintenance, amounting to €1.13 and €0.65 million, respectively. The remaining expenditures included expenditures on public infrastructure, local infrastructure, equipment, and supplies.

Box 2. Capital budget Amendments to the Budget Law envisage that in 2006, besides drawing up the current budget, the same should be done for the capital budget for a term longer than one year. The aim is to increase the value of non-financial assets (comprised of acquisition of public infrastrucutre, local infrastructure, construction buildings, land, and equipment). For this year it has been planned to draw up the capital budget for the Directorate for Public Works and the Directorate for Public Roads. During the year, legal infrastructure in this field will be supplemented by the Instructions on the preparation of the capital budget. 25This category is comprised of: communal compensations, fees and other expenses.

Table 5.3. Transfers from the central budget in the first quarter of 2006 (€ million) Transfers beneficiaries

Q1 of 2006

Plan for 2006

% of plan

Public institutions 3.87 24.58 15.74NGOs, political parties and associations 0.58 3.13 18.53Individuals 2.15 10.46 20.55Pension Fund 13.14 69.33 18.95Health Insurance Fund 1.18 7.05 16.74Employment Fund 1.39 5.57 24.96Municipalities 0.19 1.83 10.38Public enterprises 0.00 0.24 0.00TOTAL 22.50 122.19 18.41



42


Net lending of the central budget amounted to €1.58 million and was 35.6% lower as

compared to the corresponding period of the previous year. This was due to the fact that the GoM, in the first quarter of 2006, gave loans totaling €2.31 million to the following subjects: non-financial institutions (€1.26 million), individuals (€0.46 million), and other subjects (€0.40 million), while at the same time it repaid loans based on given guarantees in the country in the amount of €0.19 million26. Additionally, at the same time, the central budget received receipts from loan repayments in the amount of €0.73 million. Such a situation differs from last year when no flows on the basis of repayments occurred and when, hence, gross lending was equal to net lending in the amount of €2.45 million.

5.2 SOCIAL FUNDS In the remaining part of this chapter we will present a short analysis of budget realization within the social funds (Pension Fund, Health Insurance Fund and Employment Fund) in the first quarter of 2006. 5.2.1 Pension Fund

In the first quarter of 2006, the Pension Fund ran a deficit in the amount of €0.63 million. Overall funds for deficit financing amounted to €1.97 million and were related to privatization revenues (€2.51 million). In the analyzed period, the Pension Fund repaid €0.54 million of debt and did not take new loans. Due to the fact that the deficit was financed by disposable funds, deposits of the Pension Fund increased by €1.34 million. Total revenues amounted to €40.08 million, out of which, €26.26 million were received contributions, €13.51 million represented transfers from the republic budget, while the remaining €0.13 million represented other revenues (payment of tax claims from previous years).

Total expenditures of the Pension Fund in the

observed period amounted to €40.71 million, out of which 87.1%, or €35.47 million, were related to expenses on gross pensions (net pensions, contributions, compensations), while the remaining €5.24 million represented other revenues. 5.2.2 Health Insurance Fund In the first three months of 2006, the Health Insurance Fund ran a deficit in the amount of €0.42 million. Funds aimed at deficit financing were negative and amounted to €1.31 million, for in the observed period the Fund repaid €3.04 million of debt and, at the same time, took €1.71 million in new loans. In the analyzed period, it received grants in the amount of €0.001 million. As a result of these mentioned facts, deposits of the Fund decreased by €1.74 million. Total revenues of the Health Insurance Fund amounted to €22.38 million and were comprised of: contributions (€16.20 million), transfers (€7.73 million), and other own revenues (€1.45 million).

26 Loans based on given guarantees in the total amount of €0.19 million were repaid in the month of February.

Table 5.4. Budget of the Pension Fund (€ mil) Q1 of 2006

I TOTAL REVENUES 40.08 1. Contributions 26.26 2. Transfers (from Budget) 13.51 3. Other revenues 0.31 II TOTAL EXPENDITURES 40.71 1. Gross pensions 35.47 2. Other expenditures 5.24

III DEFICIT/SURPLUS (I-II) -0.63

IV FINANCING 1.97 1. Domestic financing -0.54 2. Foreign financing 0.00 3. Privatization revenues 2.51

V DEPOSITS CHANGES (III+IV) 1.34

Source: Pension Fund, Ministry of Finance, ISSP calculations

Monet June 2006


In the analyzed period, total expenditures amounted to €22.80 million. Current expenditures (non-interest spending and interest, excluding transfers) were at a level of €16.05 million, which represents 70.4% of actual expenditures. Transfers amounted to €6.72 million, out of which €2.33 million were related to social security transfers (other rights from the field of health protection and health insurance), and €4.39 million were transfers to institutions and individuals. Capital expenditures represented only 0.5% of total expenditures and amounted to €0.11 million. Net lending was at a level of €0.02 million, with repayment of loans based on given guarantees accounting for €0.023 million and repayment of loans accounting for €0.006 million. 5.2.2 Employment Fund

The Employment Fund is the only social fund that had a positive financial result at the end of quarter I, amounting to €3.50 million. Due to the fact that funds for financing were also positive (privatization revenues in the amount of €0.42 million), deposits of the Employment Fund also increased, by €3.92 million. In the analyzed period, additional borrowing did not occur and no grants were received.

Total revenues of the Employment Fund amounted to €9.81 million. The greatest portion of revenue (48.8%) was funds from the previous year, amounting to €4.79 million. Payment of tax claims from the previous period amounted to €2.20 million,

while contributions were at a level of €1.09 million. In the first quarter, received transfers accounted for €1.39 million. Other revenues were comprised of fees (€0.23 million) and capital revenues (€0.1 million). Total expenditures accounted for €6.26 million, out of which €1.62 million was related to current expenditures, while social security transfers (funds for redundant labor), and transfers to individuals, the Pension Fund, and the Health Insurance Fund amounted to €4.58 million. Capital expenditures amounted to €0.06 million. Net lending was at a level of €0.05 million, while given loans and repayment of loans amounted to €0.70 and €0.65 million, respectively.

Table 5.5. Budget of the Health Insurance Fund (€ mil) Q1 of

2006

I TOTAL REVENUES 22.38 1. Contributions 16.20

2. Transfers (from Budget and Pension Fund) 4.73

3. Other revenues (deposits) 1.45 II TOTAL EXPENDITURES 22.80 1. Current expenditures 16.05 2. Transfers 6.72 3. Capital expenditures 0.01 4. Net lending 0.02

III DEFICIT/SURPLUS (I-II) -0.42 IV FINANCING -1.32 1. Domestic financing -1.33 2. Foreign financing 0.00 3. Privatization revenues 0.00 4. Donations 0.01

V DEPOSITS CHANGES (III+IV) -1.74

Source: Health Insurance Fund, Ministry of Finance, ISSP calculations

Table 5.6. Budget of the Employment Fund (€ mil) Q1 of 2006

I TOTAL REVENUES 9.81 1. Contributions 1.09 2. Transfers (from Budget) 1.39 3. Other revenues (deposits) 7.33

II TOTAL EXPENDITURES AND NET LENDING 6.31

1. Total expenditures 6.26 2. Net lending 0.05

III DEFICIT/SURPLUS (I-II) 3.50 IV FINANCING 0.42 1. Domestic financing 0.00 2. Foreign financing 0.00 3. Privatization revenues 0.42 4. Grants 0.00

V DEPOSITS CHANGES (III+IV) 3.92

Source: Employment Fund, Ministry of Finance, ISSP calculations


44


CHAPTER 6. MONEY

During the first quarter of 2006, activities to further the privatization process in the banking sector were continued. As was already announced, tender for the Bank of Pljevlja was launched. The Bank of Pljevlja is one of two domestic banks in which the state owns a majority capital share. Additionally, in order to further increase citizens’ confidence in the banking sector and to increase total deposits, the Fund for Deposits Protection has begun to work. Actually, if we speak in terms of the Montenegrin banking sector, the first quarter of the current year was marked by the Project “A thousand residential loans”. This project represents something completely new on our market. In addition, a new differential required reserve rate has been implemented. The main indicators of the success of doing business in this sector (total approved loans, deposits, as well as the values of the general monetary aggregates) were characterized by stable positive growth rates during February 2006, while some indicators decreased their value as compared to December 2005. That performance is specific during the first months of every year.

6.1. MONETARY AGGREGATES During February 2006, monetary aggregates were registering slightly negative growth rates as compared to the end of last year, while at the same time, positive annual growth rates were registered by the same aggregates.

Graph 6.1. Monetary aggregates

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M0 M1 M11 M2 M21

At the end of February 2006, the monetary aggregate M0 amounted to €328.7 million, which is 6.42% lower as compared to the end of 2005. Also, the annual growth rate of this monetary aggregate was 12.76%. The monetary aggregate M1 (deposits of the central bank and government are excluded) amounted to €579.7 million in February 2006, which is 35.42% higher as compared to the same month in 2005 and 2.59% lower as compared to December 2005. The increase of M1 was influenced primarily by the growth of demand deposits in euros, which comprised the majority of bank deposits. The annual growth rate of those deposits was 90.74%. Also, a positive growth rate of 1.49% was achieved by those deposits as compared to the end of 2005.

Monet June 2006


The monetary aggregate M11 registered a positive annual growth rate of 39.88%, while as compared to December of 2005, a slight decrease of 0.28% was realized. The annual increase was mainly influenced by the increase of demand deposits in euros, which registered an annual increase of 100.57%, as well as an increase of 8.14% as compared to December 2005. At the end of February, the monetary aggregate M11 amounted to €615.2 million. In February 2006, the monetary aggregate M2 registered an annual growth rate of 48.10% and amounted to €796.7 million. Additionally influencing the increased value of M2 were term deposits in euros (without government deposits), which, compared to February 2005, increased 101.7%. As compared to December 2005, the monetary aggregate M2 registered a negative growth rate of 0.55%, while term deposits in euros increased their value by 3.21%. The monetary aggregate M21 amounted to €872.6 million at the end of February 2006, which is 57.20% higher as compared to the same month of 2005, as well as 0.75% higher as compared to December 2005. The table presented below shows growth rates reached by the monetary aggregates in February 2006 as compared to February 2005, as well as a comparison to December of 2005. Table 6.1. Monetary aggregates growth rates

2005 2006 Growth rates

II XII II II-06/XII-05 II-06/ II-05

M0 291.512 351.276 328.717 -6,42% 12,76%

Banks' deposits with CBM-Payment Operations 41.512 101.276 78.717 -22,27% 89,62%

Estimate of cash in circulation 250.000 250.000 250.000 0,00% 0,00%

M1 428.064 595.064 579.677 -2,59% 35,42%

M0 291.512 351.276 328.717 -6,42% 12,76%

Demand deposits in EUR 124.830 234.600 238.100 1,49% 90,74%

Demand deposits within banks in EUR 124.793 #DIV/0! -100,00%

Demand deposits within CBM-Payment Operations in EUR 37 #DIV/0! -100,00%

Demand deposits in other currencies 11.722 9.200 12.800 39,13% 9,20%

M11 439.820 613.518 615.241 0,28% 39,88%

M0 291.512 351.276 328.717 -6,42% 12,76%

Demand deposits in EUR 136.408 253.000 273.600 8,14% 100,57%

Demand deposits within banks in EUR 132.762 #DIV/0! -100,00% Demand deposits within CBM-Payment Operations in EUR 3.646 #DIV/0! -100,00%

Demand deposits in other currencies 11.900 9.300 12.900 38,71% 8,40%

M2 537.908 801.053 796.651 -0,55% 48,10%

M1 428.064 595.064 579.677 -2,59% 35,42%

Term deposits in EUR 102.132 199.600 206.000 3,21% 101,70%

Term deposits in other currencies 7.712 6.300 11.000 74,60% 42,63%

In February 2006, the majority of M21 was related to the aggregate M11 (70.50%) and the rest were term deposits (29.50%).


46


6.2. DEPOSITS Total deposits Total deposits were continuously growing during 2005, and this positive trend continued in the beginning of 2006. At the end of February 2006, they reached €503.1 million and were 84.18% higher as compared to the same month in 2005 and 3.11% higher as compared to the end of 2005.

Graph 6.2. Total deposits (in 000 €)

0

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Observed by deposit categories, the most important growth rates were related to physical entities that have recorded an annual growth rate of 99.10%. As compared to December 2005, these deposits registered a 3.07% growth rate and amounted to €181.1 million at the end of February. Government deposits amounted to €110.7 million in the same period and registered an annual growth rate of 119.57%, while as compared to December 2005 the growth rate was 13.14%. Deposits of non-financial institutions amounted to €166.8 million in February and registered a positive annual growth rate of 85.0% as well as a 2.98% growth rate as compared to the end of 2005. Within the non-financial institutions category, deposits of domestic private companies registered an increase of 100.49% in February 2006 as compared to February 2005 and amounted to €128.5 million; additionally, they registered a 5.27% growth rate as compared to December 2005. Also, the entrepreneurs’ deposits registered an annual growth rate of 40.25% in February 2006, as well as a growth rate of 15.99% as compared to December 2005.

Monet June 2006


Graph 6.3. Trend of different categories of total deposits

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in 0

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Financial institutions Nonfinancial institutions GovernmentPhysical entities Nonprofit organisations Other

From the total amount of deposits at the end of February 2006, 54.33% are related to demand deposits and 45.67% to term deposits. Demand deposits at the end of February 2006 amounted to €275.0 million and were 85.76% higher than the year before. On the other side, term deposits in February 2006 amounted to €231.1 million and registered an increase of 84.70% as compared to the same period last year. The term structure of deposits varies when observed by depositor. Participation of demand deposits is lowest at the Government level (31.19%) and much higher at financial, non-financial institutions, and physical entities (43.95%, 73.12% and 50.55%, respectively). Participation of domestic private company deposits in total deposits amounted to 78.45% in February 2006, while participation of entrepreneurs’ deposits within the demand deposits was 99.82%. Growth rates of the total deposits are shown in the table below -- the table shows the growth rates registered in February 2006 compared to February 2005, as well as compared to the end of 2005.


48


Table 6.2. Total deposits’ growth rates


Description/Period

II XII II II-06/XII-05 II-06/II-05

1 Financial institutions 27.651 40.070 34.886 -12,94% 26,17% Banks 14.248 17.980 10.305 -42,69% -27,67% Domestic 2.765 3.004 3.410 13,52% 23,33% Foreign 11.483 14.976 6.895 -53,96% -39,95% Other financial institutions 13.403 22.090 24.581 11,28% 83,40% Domestic 12.472 20.383 22.687 11,30% 81,90% Foreign 931 1.707 1.894 10,95% 103,44%

2 Non financial instititions 90.163 161.971 166.798 2,98% 85,00% Public non financial corporations 18.483 24.937 24.288 -2,60% 31,41% State companies 13.747 20.345 19.939 -2,00% 45,04% Publicly owned organizations 4.736 4.592 4.349 -5,29% -8,17% Other non financial corporations 71.680 137.034 142.510 4,00% 98,81% Domestic private companies 64.106 122.090 128.523 5,27% 100,49% Entrepreneurs 1.200 1.451 1.683 15,99% 40,25% Foreign companies 6.374 13.493 12.304 -8,81% 93,03%

3 Government 50.414 97.836 110.696 13,14% 119,57% Central government 12.563 20.241 27.877 37,73% 121,90% Agencies and institutions of central government 13.423 14.434 14.739 2,11% 9,80% Local government - municipalities 2.284 4.178 7.791 86,48% 241,11% State funds 22.144 58.983 60.289 2,21% 172,26%

4 Physical entities 90.981 175.750 181.147 3,07% 99,10% Domestic 77.882 157.364 160.151 1,77% 105,63% Foreign 13.099 18.386 20.996 14,20% 60,29%

5 Non profit organizations 5.329 9.457 9.532 0,79% 78,87% Domestic 4.099 7.680 7.599 -1,05% 85,39% Foreign 1.230 1.777 1.933 8,78% 57,15%

6 Other 8.630 2.832 3.055 7,87% -64,60%

TOTAL 273.168 487.916 503.114 3,11% 84,18%

The structure of total deposits by depositors in February 2006 shows that the largest depositors are non-financial institutions (32.96%) and physical entities (35.79%). Participation of domestic private company deposits in total deposits amounted to 25.39%. A significant depositor is the Government, and participation of these deposits in the total amounted to 21.87% in February 2006.

Graph 6.4.: Structure od total deposits by clients (February 2006)

6,89%

32,96%

21,87%

35,79%

1,88%

0,61%

Financial instiutions Nonfinancial instiutions Government

Physical entities Nonprofit organisations Other

Monet June 2006


Household deposits Total household deposits amounted to €181.1 million at the end of February 2006. The annual growth rate was 99.10%, while as compared to December 2005 those deposits were 3.07% higher.

GGraph 6.5. Household deposits

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When looking at the term structure of those deposits at the end of February 2006, 50.55% were demand deposits, while the rest 49.45% were term deposits. Demand deposits registered an annual growth rate of 99.66% in February 2006, while as compared to December 2005, these deposits were 2.06% lower. At the end of February 2006, they amounted to €91.6 million. Also, term savings up to 1 year registered a positive growth rate of 113.09% as compared to the same period last year. At the end of February 2006, their value amounted to €87.0 million. With respect to term deposits over 1 year, the beginning of the current year was marked by a significant decrease in their value. Namely, at the end of February 2006, these deposits amounted to €2.4 million, which was 43.75% lower as compared to the same time last year.

Graph 6.6. Annual change of deposits

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In order to continue to increase the confidence citizens have in the banking sector, as well as to increase overall deposits, the Deposit Protection Fund was begun in the beginning of 2006. Box 1. Deposit Protection Fund At the end of 2005, total deposits in the domestic banking sector amounted to €487.0 million, which is 78.2% higher as compared to the end of 2004. The structure of total deposits by depositors had changed in favor of household deposits at the end of 2005, as compared to the same time in 2004. The share of household deposits in total deposits was 35.5%. At the end of 2005, those deposits amounted to €173.0 million and realized an annual growth rate of 118.2%. This data supports the fact that confidence in the domestic banking sector has significantly increased and it is reasonable to expect a positive trend to be continued in the future. Namely, at the beginning of the current year, the Deposit Protection Fund began its work. The protection of citizens' and companies' deposits in all banks in Montenegro is its primary task. In case of a bank failure, the role of the Deposit Protection Fund is to provide efficient, simple, and fast reimbursement of deposits to depositors of the failed bank, up to the guaranteed amount. During the first few years, the guaranteed amount of deposits will be up to €5,000. The protected amount is four times lower than the amount prescribed by EU Directives. It is expected that the functioning of this Fund will contribute to the stability of the domestic financial system, as well as to increase total deposits in order to create the necessary conditions that will allow the guaranteed amount to be increased up to €20,000 in a very short period of time. In the case of a bank failure, the priorities for reimbursement are given to deposit owners, and only after that, reimbursement will be made to the Fund. The reimbursements will be paid from insolvent real estate. Every bank in the domestic banking sector became a member of this Fund. They have already paid the initial fee of 0.3% of total deposits. As of 2007, the fee that each bank must pay to the Fund will depend on the image awarded to each of them by the Central Bank of Montenegro. That means that as a higher quality and security level is provided by the bank, the lower the fee it will have to pay. Besides the initial fee, the banks have to pay an annual fee as well. According to the Managing Board of the Fund, the value of the annual fee is decided to be 0.25% of total deposits. The annual fee has to be paid quarterly. The deposit protection system in Montenegro comprises deposits of citizens and companies, residents and non-residents. That means that the Fund is not going to guarantee the reimbursement of insurance companies’ deposits, budget, local municipality units, extra budgeted, pension, investment and privatization Funds, as well as inter bank deposits. Also, the Fund does not cover deposits of the general director, members of the Managing Board of the bank, persons with special authorities and responsibilities within the bank, or those whose share in capital or in preferential shares is more than 10.0%. The Law of Deposit Protection defined the logo and the promotion material of the Fund. Every bank that is a Fund member must put the logo of this institution, as well as the announcement of its membership, within its office so that it is visible to its clients, making them aware that they are protected according to the Law, up to the prescribed amount. In addition, it is also prescribed that member banks cannot use their membership for their own promotion.

6.3. LOANS Total loans provided by Montenegrin banks continued their positive trend during the first months of 2006. The total loans provided in February amounted to €416.3 million and participated in total assets of the banking sector with 58.50%. This level is 43.13% higher as compared to the level reached in February of 2005 and 10.72% higher as compared to December 2005. Compared to February of 2005, loans approved to financial institutions decreased by 86.67%, while as compared to December 2005 their value increased 214.71%. In February 2006, a total of €0.4 million was approved as loans for those institutions.

Monet June 2006


Graph 6.7. Loans provided by banks in Montenegro

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Loans to non-financial institutions continued registering positive growth rates, so at the end of February 2006 a total of €268.2 million in loans had been approved, 39.07% higher than in the same period last year. The growth rate as compared to December 2005 was also positive (11.90%). A portion of these loans, loans to domestic private companies in February 2006, amounted to €229.1 million and registered an annual growth rate of 37.57%, as well as a growth rate of 11.17% as compared to the end of 2005. Loans to physical entities were 48.88% higher in February 2006 compared to the same month in 2005 and the total amount provided to physical entities was €110.7 million. The growth rate of these deposits as compared to December 2005 was 6.15%. Loans approved for the Government amounted to €35.8 million at the end of February 2006, which is 76.71% higher as compared to the same month in 2005. Non-profit organizations were approved a total of €1.0 million in loans at the end of February, which is 681.45% more than in the same period last year and 2.76% more as compared to the end of 2005. The amounted growth rates of total loans in February 2006, as compared to the same month last year, as well as to the end of 2005 are presented in the table below.


52


Table 6.3. Total loans’ growth rates


Description/Period II XII II II-06/XII-05 II-06/II-05

1 Financial institutions 3.210 136 428 214,71% -86,67% Banks 500 37 34 -8,11% -93,20% Domestic 500 37 34 -8,11% -93,20% Foreign 0 0 0 #DIV/0! #DIV/0! Other financial institutions 2.710 99 394 297,98% -85,46% Domestic 2.705 99 394 297,98% -85,43% Foreign 5 0 0 #DIV/0! -100,00%2 Non financial institutions 192.828 239.633 268.159 11,90% 39,07% Public non financial institutions 18.595 27.109 31.401 15,83% 68,87% State companies 10.644 19.646 23.457 19,40% 120,38% Publicly owned organizations 7.951 7.463 7.944 6,45% -0,09% Other non financial corporations 174.233 212.524 236.758 11,40% 35,89% Domestic private companies 166.511 206.060 229.068 11,17% 37,57% Entrepreneurs 5.928 4.386 4.678 6,66% -21,09% Foreign companies 1.794 2.078 3.012 44,95% 67,89%3 Government 20.281 30.785 35.839 16,42% 76,71% Central government 6.726 9.864 13.530 37,17% 101,16% Agencies and institutions of central government 364 5.409 5.218 -3,53% 1333,52% Local government - municipalities 2.199 3.809 3.978 4,44% 80,90% State funds 10.992 11.703 13.113 12,05% 19,30%4 Physical entities 74.377 104.316 110.731 6,15% 48,88% Domestic 74.287 104.208 110.639 6,17% 48,93% Foreign 90 108 92 -14,81% 2,22%5 Non profit organizations 124 943 969 2,76% 681,45% Domestic 68 943 969 2,76% 1325,00% Foreign 56 0 0 #DIV/0! -100,00%6 Other 0 127 125 -1,57% #DIV/0! TOTAL 290.820 375.940 416.251 10,72% 43,13%

At the end of February 2006, domestic private enterprises were approved a total of €229.1 million in loans, which represents an annual increase of 37.57% as well as an increase of 11.17% when compared to the end of the previous year. Entrepreneurs were approved a total of €4.7 million in loans at the end of February 2006, which is 21.09% lower as compared to the same time last year, but 6.66% more as compared to December of 2005. The data at the end of March 2006 shows that 24.0% of all enterprises and entrepreneurs have a blocked bank account and the total debts of those enterprises amount to more than €75.0 million. Those facts must be taken into consideration when approving loans in the future in order to avoid situations of mandatory debt collection. Box 2. Every fourth enterprise faces the liquidity problem According to the official data of the Central Bank, on March 31 2006, a total of 7,702 enterprises in Montenegro had blocked bank accounts; this is 1.81% higher as compared to February. At the end of March, in official evidence of the Payment Operations System, there were a total 31,569 enterprises and entrepreneurs. The total debts attached to those accounts that were blocked amounted to €70.74 million, which is 6.55% lower as compared to the month before. The mentioned decrease was the result of a mandatory collection. Total debts of the enterprises whose accounts were blocked were €75.7 million at the end of February. It is important to mention that at the end of March the debt concentration is relatively high. For example, ten of the major debtors share in the total debt is 28.0% (€19.84 million). Additionally, 50 major debtors present 0.16% of the overall number of debtors, and they have a 46.62% share of the total debt (€32.98 million). The majority of those enterprises have a short-term block on their accounts. A few enterprises, but those who represent the major debtors’ accounts, are blocked for the long term. For example, 14 out of 50 debtors that have the highest debts have permanently blocked accounts, 29 have blocked accounts for more than 10 months, and the remaining seven enterprises have blocked accounts for up to 10 months. At the end of 2005, a total of 7,668 enterprises had blocked accounts and their total debt was €73.99 million, and the high insolvency of enterprises continued during the first quarter of 2006. As compared to 2003, the total number of insolvent enterprises was two times lower, and the overall debt was €27 million lower.

Monet June 2006


Graph 6.8. Structure of provided loans

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Financial instiutions Nonfinancial instiutions Government

Physical entities Nonprofit organisations Other

In February 2006, the majority of total loans were approved to non-financial institutions (64.42%), while the share of loans approved to physical entities accounted for 26.60%. Also, 55.03% of total approved loans were related to domestic private enterprises. 6.4. THE EVENTS THAT HAVE MARKED THE FIRST QUARTER OF 2006 6.4.1. The final phase of the privatization process in the banking sector The privatization process in the Montenegrin banking sector came into its final phase. Today, 86.24% of the domestic banking sector is privatized, i.e. 13.76% of capital is related to state. The state has the majority capital in two domestic banks (Bank of Pljevlja and Bank of Niksic). The privatization process of those banks is planned to be finished this year; their realization began at the very beginning of 2006. Box 3. Privatization of the Bank of Pljevlja In the first quarter of the current year the process of privatization in the banking sector has continued. Montenegro entered 2006 with a banking sector that was almost 90.0% privatized. The Banks of Niksic and Pljevlja are the last ones waiting for privatization. Tender for the majority package of shares of the Bank of Pljevlja was closed at the end of the first quarter of 2006, after extending the deadline by three weeks. Namely, by public invitation 78.7% of the state capital was offered, and only the Consortium of Atlas Mont Bank, Atlas Mont Fund and Company Fin Invest from Podgorica submitted offers. Tender documentation was ransomed by four legal entities, among them one bank from Liechtenstein and the Montenegrin HLT Fund. Two Investment Funds, German Czech and French, announced their participation in tender also, so the main goal of prolonging the deadline was to improve the quality of the offers. Tender for the Bank of Pljevlja was announced on December 2nd, and the offer included 56.4% of its shares that belong to the state, 17.4% of the Employment Agency, and 4.9% of the Development Fund. All legal entities that have realized an average of €1.5 million during the last three years, as well as citizens that are not legally pursued had the possibility to participate in the tender. The price of tender documentation was €3,000 and those who had an interest had to pay a deposit or have a €100,000 guarantee of a first class international bank. The Bank of Pljevlja, one of the two banks with the majority of state capital, was established in 1990. Last year the total income of this bank was €24,000. Its capital value is €5.2 million, and the value of one share is €51.13. Its shares are quoted on the Montenegro Stock Exchange, on its B list.


54


6.4.2. Adopted New Required Reserve Policy In order to give rise to deposits in domestic banks, the Council of the Central Bank of Montenegro adopted the New Required Reserve Policy. The last time this policy was modified was almost three years ago when the required reserve rate was reduced from 50.0% to 23.0%. 6.4.3. Project “A thousand residential loans” At the beginning of April 2006, the Government of Montenegro and the Bank of Podgorica, the Montenegrin Commercial Bank, and Montenegro Bank signed a contract about the realization of the project named “1,000 residential loans”. Very soon, Hypo Alpe Adria Bank, which officially began its work in the beginning of April, joined the project. With this project, 600 out of 1,000 residential loans are assigned to employees in Ministries and other Governmental bodies, courts, or Education; 200 residential loans were assigned to the Health Insurance Fund and Public Health Organization employees, while the remaining 200 were assigned to citizens. Box 5. Residential loans The main goal of this project is to improve the living standard of the citizens, primarily those who work in state organizations, Health Care, and Education. The project is comprised of 200 loans of €5,000 for a period of 5 years for apartment reconstruction (monthly rate is €90), 300 loans for up to €15,000 for a period of up to 10 years for resolution of inappropriate living space (monthly rate is €150), and 500 loans for up to €30,000 for a period of up to 20 years for buying a place to live (monthly rate is €180). If citizens are interested in a loan that is higher than €30,000, this amount will be approved under the mentioned conditions, and the rest will be a separate arrangement between the interested citizen and the commercial bank. The annual income rate for all four banks is 4.0%. The banks income rate is 6.4%, and the remaining 2.4% is subsidized by the Government, representing an amount of €3.3 million, under the condition of immediate reimbursement.

When deciding whether to apply for one of the proposed loans, the interested person should consider all of the conditions and calculate the overall expenses of buying an apartment by using one of the above described loans. Considering only the basic conditions of getting a residential loan, such as the interest rate, the payback period, as well as assurance instruments is not enough. There are also life and real estate insurance expenses, as well as expenses related to court services expenses – none of these should be overlooked.

Box 4. Required reserve The New Required Reserve Policy brought several modifications, among them, the most important are the following: implementation of differentiate required reserve rate, reduction of its value, as well as spreading of the present basis. Until now, the required reserve rate of 23.0% was applied on demand deposits as well as on term savings up to 30 days. By the New Required Reserve Policy, the regular required reserve rate on demand deposits and term savings up to 90 days is 19.0%. Additionally, the required reserve rate on term deposits over 90 days is 5.0%. There is no required reserve rate on term savings over 1 year. Also, by the new required reserve policy, the Central bank of Montenegro increased the share of required reserve on which interest has to be paid from 25% to 40%. The interest rate on the missing part of the required reserve is decreased from 12.0% to 11.0% as well. According to the clauses of the New Required Reserve Policy, every commercial bank is allowed to convert into t-bills no more than 10.0% of its overall required reserve resources.

Monet June 2006


Box 6. Monthly fee is not the only expenditure when taking a residential loan If you have a good salary that allows you to be one of the lucky ones who can get a residential loan, you should also be aware that the monthly fee is not the only monthly expenditure for a new apartment. In addition to the basic conditions of getting a residential loan, such as interest rate, the payback period, and assurance instruments, citizens will also have a few extra expenses to the bank as well as to the court. The practice of European banks that are entering the Montenegrin financial market requires all citizens that apply for a residential loan to pay life, as well as real estate, insurance. For example, while applying for a residential loan at one of the banks that have joined the project “1,000 residential loans”, the interested person must pay both life and real estate insurance, and both policies must be paid to the bank. Additionally, the real estate has to be insured against basic, as well as additional, risks. The value that should be paid for life insurance depends on the applicant’s age, the insurance term, and the loan value. The loan applicant must be at least 23 years old at the time of applying and no more than 65 years old when the last fee will be paid. For example, a client who is 35 years old wants to take a loan of €30,000 and the payment period is 20 years. If we put that data in the adequate table, we will get a ratio of 56.69, which should then be multiplied by the value of the loan. Doing so results in a total of €1,700 that will need to be paid for life insurance by the client. By using the same methodology, the lowest amount that any applicant would be required to pay for life insurance is €480, this would result in a case where the applicant is 23 years old, wants to take a €20,000 loan, and the payback period is 20 years. The real estate insurance policy is a much lower expenditure than life insurance and the insurance sum has to be appropriate to the structural value of the real estate. While applying for residential loans, applicants also have to consider expenses regarding courts. Namely, the mortgage is one assurance instrument of which its establishment must be paid at court and the price is about €230. Also, many other documents have to be certified by the court (contracts, personal documents, receipts, etc.), and all of them have to be paid. The price of contract certification depends on the value of the real estate, so if you want to buy an apartment for €60,000, you will have to pay €168 to the court for the contract certification.

After a detailed analysis of the information mentioned above, an interested loan applicant can have a complete picture about the expenses that come with the decision of taking a residential loan. The loan conditions that are offered vary from bank to bank and they should be considered when choosing the offer that is most suitable, according to the financial situation of each interested person. Box 7. The conditions of getting a residential loan in two Montenegrin banks Bank 1 offered residential loans addressed primarily for citizens with the following conditions: applicant must be more than 23 and less than 58 years old (to be mostly 65 years old at the moment of paying the last fee), must have a permanent job, must have an average monthly salary, and must have a place to live. The payment period is from 7 to 5 years, the effective interest rate is 6.86%, and the ballast on the monthly salary can be up to 50.0%. Interested citizens must hold an account in that bank and receive at least one salary over that account. The participation of applicant is up to 20.0% of the loan value, but participation is not necessary if the applicant has a real estate mortgage that is at least 25.0% more valuable than the required loan. The minimal loan is €10,000, while there is no maximum limit. In order to protect its interest, the bank requires that the client have life insurance or estate insurance. The annual insurance fee for persons who are 35 years old who have taken a loan of €30,000 for a 25-year period is from €50 to €70. The insurance policy can be paid for the first year, while for the subsequent periods it will be added to the monthly fee of the loan. For example, if the client wants to buy an estate priced at €30,000 and has a 20.0% share of the estate value, the rest of the money will be repaid during a 25-year period through monthly fees of €162.8. The required monthly salary of the debtor, as well as the endorser, must be at least €325.6. As a condition for getting a residential loan, a mortgage on the real estate that is the loan subject or a mortgage on some other real estate that is owned by the applicant is needed. Besides residential loans, this bank also offers loans for the reconstruction of apartments. These loans will be from €5,000 to €30,000. These loans are more favorable because of the shorter period of repayment, which is 5 to 10 years. The nominal interest rate is 4.17% multiplied with EURIBOR, the referent interest rate for Euro on the international market. If for example a client applies for a loan under €10,000, the bank protects


56


its interest by putting administrative prohibition on the client’s salary, by bond or bond proxy; while for amounts higher than €10,000 €, life insurance and real estate insurance policies, as well as a mortgage on that or some other real estate, are necessary to be paid to bank. Up to one half of the loan can be paid in cash if the client has to pay for structural works or some other services for which a commercial invoice cannot be received. Interested citizens can apply for a residential loan at Bank 2 under the following conditions: the ballast on the monthly salary can be up to 40.0%, there is also the possibility of payment up to 25.0% in cash, and participation is not necessary. The effective interest rate is 4.06%, the fee is 0.5% for regular clients, and there must exist endorsers or a mortgage, depending on payback period, for security. The client must have been employed for at least six months in an undefined period of time and the monthly fee has to be up to 40.0% of the regular monthly incomes, reduced for current obligations or collective family incomes and reduced for living costs. For loans of up to €7,000, one or more solvent endorsers is necessary, and for loans over €7,000, an estate mortgage that is valued twice as high as the loan amount is necessary. For example, for a loan of €5,000 in this bank, for a period of 5 years, the client has to pay €92 monthly, and the minimal monthly salary of the client has to be €184. For a loan of €15,000 taken for a period of 5 years, the monthly fee is €276 and the minimal monthly salary has to be €552, while for the same loan taken for a period of 10 years, the monthly fee is €151 and the minimal required monthly salary is €303. For a loan of €30,000 taken for a period of 5 years, the monthly fee is €552 and the minimal salary €1,103, while for the same loan taken for a period of 10 years, the monthly fee is €303 and the minimal required monthly salary is €605 € and if this same loan were taken for 20 years, the monthly fee would be €181 with a monthly salary requirement of at least €361. To complete a loan application, the following documentation is necessary: completed application form, verification of monthly salary, two administrative prohibitions, bond, state of account, and passport or ID card photocopy. The endorser must also provide verification of monthly salary, a declaration certified by the court, as well as a photocopy of their ID card.

6.4.4. Interest rates The average weighted nominal active interest rate was 10.89% at the end of February 2006, while the appropriate effective interest rate was 12.0%. As compared to December 2005, the average weighted active interest rate registered a 0.13% increase in February 2006 (in December 2005 its value was 10.76%), while in the same period, the appropriate effective interest rate decreased its value by 0.11% (in December 2005 its value was 12.11%).

Monet June 2006


CHAPTER 7. CAPITAL MARKET

The beginning of 2006 was marked with stability on the capital market of Montenegro; namely, turnover and the number of transactions realized on the Montenegrin exchanges remained constant. Similarly, the stock exchange indices had an almost rectilinear trend. However, new positive trends and high growth rates of turnover on the stock exchanges are expected in 2006, as well as an inflow of foreign investments. 7.1. INDICES27 In this chapter we will present our analysis of the three stock exchange indices in Montenegro during the first quarter of 2006. The trend of the indices’ values in 2005 and the first three months of 2006 is presented in the following two graphs.

Graph 7.1 Stock exchange indices NEX 20 and NEX PIF

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Source: NEX Montenegro As shown in graph 7.1, both indices of the NEX Montenegro stock exchange had stable growth rates in the first quarter of 2006. We will provide analysis of each index separately. The NEX Montenegro stock exchange index, NEX 20, remains the index with the highest registered values. NEX 20 represents shares of the twenty companies with the largest market capitalization and liquidity on the NEX Montenegro stock exchange28. The highest value in 2006 for the index was registered on January 19th in the amount of 10,654 points. Compared to the previous year, the index value increased 320%, while compared to its initial value, the index is

27 There are three stock exchange indices on the Montenegrin capital market. Montenegroberza introduced one index – MOSTE, which include prices of 35 securities, including investment units of all six Funds. NEX Montenegro introduced two indices: NEX 20 and NEX PIF. NEX 20 represents shares of the twenty companies with the largest market capitalization and liquidity on the NEX Montenegro stock exchange. NEX PIF represents the price trend of the investment units of MIFs (according to the last index revision the participation of the MIFs in the index is as follows: HLT – 23.52%, Euro Fund – 20.09%, Trend– 19.25%, Atlasmont – 17.62%, Moneta – 10.76% and MIG – 8.77%). 28 According to the last index revision (December 15, 2005), the companies with the highest participation in this index are: “Electric Company”, “Telekom”, “Port of Bar”, “Jugopetrol” and “Budvanska Rivijera.”

Stable trend of turnover, number of transactions and index values marked the first quarter of 2006.


58


valued at more than 10 times its initial value. The lowest value for the index occurred at the beginning of January (9,825 points), and throughout the quarter, its value oscillated around 10,000 points. Shares of the Podgoricka Bank, Telekom, the Electric Power Company of Montenegro AD Niksic, the Brewery Trebjesa, the Port of Bar, and Jugopetrol had the greatest influence on the index value. The second index of the NEX Montenegro stock exchange, NEX PIF, also exhibited a stable value trend during the first quarter of 2006. The highest index value was reached on January 24th and amounted to 9,401 points. Compared to the initial index value, this represents a nine-fold increase. Additionally, compared to the same period last year, the index value increased 480%. The lowest index value in 2005 occurred at the beginning of the year and amounted to 7,992 points. The index value was influenced with shares of all six Mutual Investment Funds, par excellence Eurofund, Atlas Mont, and Trend. The next graph presents the values of MOSTE, the index of Montenegroberza in 2005 and 2006. Analysis will be focused on 2006.

Graph 7.2 Stock exchange index MOSTE

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Source: Montenegroberza Values of the MOSTE in the first quarter of 2006, similar to the other two indices, showed a trend of stability. The value of the index was between 480 and 498 index points. The highest index value was reached on February 16th and amounted to 498 points. Compared to the same period in 2005, the value of the index increased more than 300%. Compared to the initial index value, the value of MOSTE in this analysis is almost five times greater. The greatest influence on the index value was had by shares of KAP, Coal Mine Pljevlja, Plantaze, Lovcen Insurance Fund, and Adriatic Shipyard, as well as shares of all six Mutual Investment Funds in Montenegro.

Monet June 2006


7.2 TURNOVER ON STOCK EXCHANGES Table 7.1. Stock exchange trade in Montenegro

MONTH MONTENEGROBERZA NEX MONTENEGRO TOTAL

TURNOVER (in €) TURNOVER (in €) TURNOVER (in €)

Primary Secondary Total Nu

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Total 03 8,799,736 17,636,926 26,436,662 5,993 1,990,881 15,126,802 17,117,683 15,331 10,790,617 32,763,728 43,554,345 21,324

Total-04 1,646,288 17,239,990 18,886,278 25,703 2,584 2,399,5391 23,997,975 31,654 1,648,872 41,235,381 42,884,253 57,357

Jan-05 0 605,009 605,009 1,992 0 1,886,401 1,886,401 3,007 0 2,491,410 2,491,410 4,999

Feb-05 0 1,161,632 1,161,632 2,615 0 9,708,671 9,708,671 4,719 0 10,870,303 10,870,303 7,334

Mar-05 11,964 3,430,230 3,442,194 3,919 0 39,747,684 39,747,684 6,794 11,964 43,177,914 43,189,878 10,713

Apr-05 137,219 2,794,549 2,93,768 2,971 0 17,486,055 17,486,055 6,202 137,219 20,280,604 20,417,823 9,173

May-05 0 5,783,934 5,783,934 4,241 0 7,453,604 7,453,604 4,214 0 13,237,538 13,237,538 8,455

Jun-05 0 5,531,852 5,531,852 4,225 0 1,620,456 1,620,456 3,888 0 7,152,308 7,152,308 8,113

Jul-05 0 4,797,211 4,797,211 4,453 0 1,719,889 1,719,889 4,017 0 6,517,100 6,517,100 8,470

Aug-05 1,552,912 4,447,391 6,000,303 4,655 0 4,592,919 4,592,919 4,858 1,552,912 9,040,310 10,593,222 9,513

Sep-05 115,023 4,705,463 4,820,486 5,471 0 5,737,850 5,737,850 5,271 115,023 10,443,313 10,558,336 10,742

Oct-05 0 9,962,236 9,962,236 6,342 0 8,371,492 8,371,492 5,474 0 18,333,728 18,333,728 11,816

Nov-05 0 1,6198,399 16,198,399 6,598 0 10,065,888 10,065,888 6,450 0 26,264,287 26,264,287 13,048

Dec-05 1,019,364 2,0062,965 21,082,329 4,291 14,093 7,391,471 7,405,564 4,396 1033457 27,454,436 28,487,893 8,687

Total 05 2,836,482 79,480,871 82,317,353 51,773 14,093 115,782,380 115,796,473 59,290 2,850,575 195,263,251 198,113,826 111,063

Jan-06 1,260 3,858,045 3,859,305 2,808 0 6,080,913 6,080,913 3,424 1,260 9,938,958 9,940,218 6,232

Feb-06 100 7,871,109 7,871,209 3,805 5,000 4,151,866 4,156,866 3,784 5,100 12022975 12,028,075 7,589

Mar-06 1,000 6,692,418 6,693,418 3,537 0 4,071,839 4,071,839 3,821 1,000 10,764,257 10,765,257 7,358

Total 06 2,360 18,421,572 18,423,932 10,150 5,000 14,304,618 14,309,618 11,029 7,360 32,726,190 32,733,550 21,179

Total turnover realized in the first quarter of 2006 on both stock exchanges amounted to € 32.72 million, and a total of 21,179 transactions occurred. Compared to the same quarter of 2005, turnover decreased 43%; this decrease was mainly caused by trade of Telekom shares that was intensified in March of 2005. The number of realized transactions was also lower in the first quarter of 2006 as compared to 2005, down 8%. Market capitalization in March 2006 amounted to € 1.071 million, which is slightly lower compared to the end of 2005. However, if we compare capitalization in March 2006 to March 2005, the increased value of the companies on the Montenegrin stock exchanges is clear (more than 310%). Graph 7.3 presents turnover and the number of transactions in 2005 and the first quarter of 2006.


60


Graph 7.3 Total turnover and number of transactions

0

5000000

10000000

15000000

20000000

25000000

30000000

35000000

40000000

45000000

50000000

Jan-

05

Feb-

05

Mar

-05

Apr-

05

May

-05

Jun-

05

Jul-0

5

Aug-

05

Sep-

05

Oct

-05

Nov

-05

Dec

-05

Jan-

06

Feb-

06

Mar

-06

0

2000

4000

6000

8000

10000

12000

14000

total turnover number of transactions

Source: NEX Montenegro and Montenegroberza As graph 7.3 shows, the lowest turnover was realized in January 2006 (€ 9,940,218) and the highest in February (€ 12,028,075). A similar situation occurred with the number of transactions, with the fewest transactions being realized in January - 6,232 transactions, and the greatest number of transactions being realized in February – 7,589 transactions. The average monthly turnover in the first quarter of 2006 was approximately €10.9 million. This is an obvious decrease when compared to the same period in 2005, when it was approximately € 18.8 million. As in previous years, in 2006, the majority of turnover was realized on the secondary market. Namely, total turnover realized on the secondary market amounted to €32,726,019, or 99.90% of total trade. This means that in the first quarter of 2006 there were almost no primary emissions. Namely, trade on the primary market came to a negligible 0.1% of the total market.

Graph 7.4 Primary and secondary market

0

5000000

10000000

15000000

20000000

25000000

30000000

35000000

40000000

45000000

Jan-

05

Feb-

05

Mar

-05

Apr-

05

May

-05

Jun-

05

Jul-0

5

Aug-

05

Sep-

05

Oct

-05

Nov

-05

Dec

-05

Jan-

06

Feb-

06

Mar

-06

primary secondary

Source: NEX Montenegro and Montenegroberza

Monet June 2006


7.2.1. Trade on the secondary market As previously mentioned, almost all of the trade that was realized on the Montenegrin Stock exchanges occurred on the secondary market. Namely, total turnover on the secondary market in the analyzed period amounted to € 32,726,190, making 99.9% of total trade. Additionally, 21,173 transactions occurred on the secondary market during this period. The structure of turnover was similar to that in previous years. Namely, the majority of turnover on the secondary market was realized with shares (around € 24 million or 82%), followed by shares of MIFs (€ 6.5 million or 10%), and the minority of turnover occurred with old foreign currency savings bonds (€ 1.9 million or 8%). The structure of trade on the secondary market is presented in the following graph.

Graph 7.5 Structure of trade on the secondary market

Investments units of MIFs -10%

Old foreign currency saving bonds - 8%

Shares82%

Source: NEX Montenegro and Montenegroberza In the following text we will analyze each type of security individually. Trade with shares In the first quarter of 2006, shares of around 65 companies were traded on the NEX Montenegro stock exchange. Similarly, on the other stock exchange in Montenegro – Montenegroberza, shares of around 60 companies were traded. The next two tables present the shares with the highest realized turnover and the highest number of transactions in the first quarter of 2006 on both stock exchanges.


62


Table 7.2 Ten shares with the highest realized turnover in the first quarter of 2006.

Issuer Turnover in €

“HTP BOKA AD HERCEG NOVI” € 3.68 million

“PODGORICKA BANKA AD PODGORICA” € 2.44 million

“TELEKOM CRNE GORE A.D. PODGORICA” € 2.43 million

“KOMBINAT ALUMINIJUMA PODGORICA” € 2.15 million

“SOLANA BAJO SEKULIC ULCILJ” € 1.85 million

“ELEKTROPRIVREDA CRNE GORE" A.D. NIKŠIĆ € 1.66 million

"PLANTAZE AD" PODGORICA” € 1.17 million

”TREBJESA AD NIKSIC” € 767,581

“HTP ALBATROS” ULCINJ € 732,292

AD LUKA BAR € 611,490

Source: Stock exchanges in Montenegro, ISSP calculations As table 7.2 shows, shares of the ten companies realized € 17.4 million of turnover and accounted for 54% of total turnover on the secondary market. Table 7.3 presents the shares of companies that experienced the highest number of transactions, totaling 5,772. This accounts for 28% of the total number of transactions realized in the first quarter of 2006. Table 7.3 Ten shares with the highest number of transactions realized in the first quarter of 2006

Issuer Number of transactions

“KOMBINAT ALUMINIJUMA” 1,283

“AD LUKA BAR – BAR” 702

"ELEKTROPRIVREDA CRNE GORE" A.D. NIKŠIĆ 699

“AD PLANTAŽE” 674

“HTP BUDVANSKA RIVIJERA” 632

“JADRANSKO BRODOGRADILISTE BIJELA A.D.” 578

“DUVANSKI KOMBINAT” PODGORICA 344

“JUGOPETROL AD KOTOR” 316

“HTP BOKA” HERCEG NOVI 304

“RUDNICI BOKSITA NIKSIC” 240

Source: Stock exchanges in Montenegro, ISSP calculations Trade with shares of Mutual Investment Funds (MIF)29 As in previous years, in the first three months of 2006 shares of all six Funds participated in the stock exchange trade and a total of € 6.59 million in turnover was realized (64% on Montenegroberza and 56% on NEX Montenegro). Additionally, a total of 10,998 transactions were realized (36% on Montenegroberza and 64% on NEX Montenegro). It is interesting to note that the number of transactions realized with these securities account for 52% of the total transactions. Turnover and number of transactions with these securities are presented in the next graph.

29 Two of six Funds in 2005 were transformed into the Mutual Investment Funds – Euro Fund and Moneta.

Monet June 2006


Graph 7.6 Turnover with shares of MIFs

0

1000000

2000000

3000000

4000000

5000000

6000000

7000000

Jan-

05

Feb-

05

Mar

-05

Apr-

05

May

-05

Jun-

05

Jul-0

5

Aug-

05

Sep-

05

Oct

-05

Nov

-05

Dec

-05

Jan-

06

Feb-

06

Mar

-06

0

1000

2000

3000

4000

5000

6000

7000

turnover "number of transactions"

Source: NEX Montenegro and Montenegroberza The next table presents the prices and realized turnover with each MIF share. Table 7.4 Prices and turnover with MIFs shares in first quarter of 2006

Fund Min price Max price No of transactions Turnover

"ATLAS MONT" 0.0700 0.0900 1,479 1,049,964

"EURO-FOND" 0.0604 0.0849 3,028 2,417,353

"HLT-FOND" 0.0370 0.0499 2,300 612,261

"MIG" 0.0616 0.0868 745 412,067

"MONETA" 0.0601 0.0760 1,687 741,007

"TREND" 0.1000 0.1200 1,390 1,130,064

Source: Stock exchanges in Montenegro, ISSP calculations As we can see from the previous table, shares of the MIF Euro Fund had the highest turnover (€ 2.41 million), followed by Trend (€ 1.13 million) and Atlas Mont (€ 1.04 million). Shares of the MIF MIG had the highest growth rate in these three months of 2006 – 40.91%; also showing high growth rates were shares of the Euro Fund – 40.56% and shares of the HLT Fund – 34.86%. Trade with shares of old foreign currency savings bonds Data for the first quarter of 2006 shows that old foreign currency bonds continue to interest investors. Namely, trade with this security was intensified in the first quarter of 2006 and made 8% of total trade. The bonds that were most interesting to investors in the analyzed period were those with maturity in 2014, 2013, 2015 and 2011. Namely, trading among these bonds represents 50% of all trade with this security.


64


Table7.5. Old foreign currency saving bonds on both stock exchanges

SECURITY NO OF TRANSACTION TURNOVER % OF TURNOVER

Bonds with maturity in 2006 56 81,981 4.21%












TOTAL 810 1,946,133

Source: NEX Montenegro and Montenegroberza, ISSP calculations CONCLUSION The beginning of 2006 was marked by stagnation in trade with securities on the Montenegrin stock exchanges, as well as by a growing price trend. This is also indicated in the trend of the stock exchange indices, which were almost rectilinear (with small oscillations). After the “expansion” of stock exchange trade last year, this “lull” on the Montenegrin stock exchanges created some disbelief among economists and common citizens. However, the situation on the Montenegrin stock exchanges is not unusual; this is happening in all markets, even the more developed ones. Therefore, this situation shouldn’t be viewed or interpreted as a negative sign. Within each market, in each economy, activity will experience increases and decreases from time to time; this is especially expressed on the stock exchanges. The expectations of the market participants have a great influence on trade. Therefore, settling the state issue of Montenegro would certainly have a positive influence on the further development of the market and stock exchange trade. There is still the potential for further growth in the price of shares. Many of the shares on the stock exchanges are still undervalued, and their market value is long under the nominal. Additionally, foreign investors have shown interest in the Montenegrin capital market; and at the recent presentation of the Montenegrin capital market to investors in Slovenia and Croatia, this segment of the Montenegrin economy was evaluated as ideal for investments, from the aspect of legal safety, regulation, and undervalued shares.

Monet June 2006


CHAPTER 8. EXTERNAL SECTOR

8.1. TRADE BALANCE The estimated trade deficit, as the difference between exports and imports of goods and services exchanged with foreign countries, amounted to € 100.4 million or 7.2% less than in the same period of the previous year. Deficit reduction was achieved because exports grew faster than imports of goods and services in the above mentioned period of 2006. Goods trade According to the ISSP’s estimation, the total goods trade (imports plus exports) in the first quarter of 2006 amounted to € 311.5

million or 1.3% more than in the corresponding period of the previous year. Estimated export of goods amounted to € 106.5 million in the first quarter of 2006 or 4.4% more than in the same period of the previous year. Estimated import of goods amounted to € 204.9 milllion in the first quarter of 2006 and was almost on the same level as in the corresponding period of 2005. Overall, the ratio of exports to imports in the first quarter of 2006 was 51.9% or 2.3 percentage points more than in the same period of the previous year. The total goods trade deficit in the first quarter of 2006 amounted to € 98.4 million, a decrease of 4.9% due to the increase of exports compared to the first quarter of 2005. According to the projection made by the ISSP, total export of goods will amount to € 599.2 million in 2006, or 37% more than in the previous year, while total import of goods will amount to € 1.07 billion or 13.8% more than in the corresponding period of the previous year. The projected goods trade deficit will amount to € 470.8 million in 2006, or 7.5% more than in the previous year. Balance of services Estimated export of services amounted to € 28.3 million in the first quarter of 2006 or 34.5% more than in the same period of the previous year, due to the increase of the total revenues of tourism. Estimated import of services amounted to € 29.5 million or 30.5% more than in the corresponding period of the previous year. The services balance deficit was negative in the first quarter of 2006, but, according to the estimation, it was 25% lower compared to the first quarter of 2005. According to the ISSP’s estimation, total export of services will amount to € 354.9 million in 2006 or 12.8% more than in the previous year. As result, total surplus of the balance of services will amount to € 223 million or 16.8% more than in 2005.

Due to a lack of official data related to the Balance of Payments, the ISSP estimated the situation within the external sector in the first quarter of 2006. As far as this topic is concerned, the accent was put on the Trade Balance as a part of the total Balance of Payments. According to the estimation for the first quarter of 2006, the trade balance deficit was reduced, and was followed with a surplus within the transfers balance as well as the income balance. In total, this contributed to the improvement of the balance of payments compared to the previous quarter. In addition, the current account deficit in the first qarter of 2006 was on the same level as in the corresponding period of the previous year.


66


CHAPTER 9. REGIONAL COMPARISON

9.1 MACROECONOMIC INDICATORS

Real GDP growth was positive in all SEE countries in 2005 and amounted to 6% in Albania, 5.2% in Bosnia and Herzegovina, 6.4% in Bulgaria, 4.3% in Croatia, 4% in Macedonia, 4.1% in Montenegro, 5.9% in Serbia, and 5.2% in Romania. The positive

trend of economic growth continued in the first quarter of 2006, when, compared to the same period of the previous year, positive growth of total production and GDP was registered.

Graph 9.1 presents the cumulative GDP index for most countries in the region, starting with 1996:

Graph 9.1 Real GDP in South-Eastern Europe (1996=100)

80

100

120

140

160

180

200

220

240

1996 1997 1998 1999 2000 2001 2002 2003 2004 2005*

Albania MontenegroBosnia and Herzegovina BulgariaCroatia RomaniaMacedonia Serbia

Source: MMF,CIA, central banks web sites and the ISSP

As the sector with a rather important contribution to the creation of GDP in almost all SEE countries, industry increased its production. The physical volume of industrial production increased in the first quarter of 2006 with the highest annual growth rates in Bosnia and Herzegovina (5.9%), Serbia (5.8%), Croatia (5%), Romania (3.5%), and Montenegro (3.0%) in March 2006.

Almost all SEE countries characterized low inflation rates, except Serbia and Romania. However, the inflation rate in Romania has significantly fallen in the last two years, while Serbia is the only country in the region with a two-digit inflation rate. As far as the external factors that cause inflation are concerned, in 2005 as well as in the first quarter of 2006, an increase of oil prices was dominant. However, on the other hand, the appreciation of the Euro against the US dollar supported decreasing inflation in the above mentioned periods. In most Southeast European countries, the currencies are fixed to the Euro and thus, the appreciation of the Euro has meant the appreciation of these currencies against the US dollar, which in turn caused a decrease in the prices of important imported goods denominated in US dollars. Internal factors of inflation, especially in Serbia, were the high demand and macroeconomic policy changes. The annual CPI inflation rate in March 2006 was the lowest in Albania (1.5%), Montenegro (2.8%), Croatia (3.0%), and Macedonia (3.0%), while on the other hand, it was the highest in Serbia (13.8%), Romania (8.4%), Bulgaria (6.6%), and Bosnia and Herzegovina (5.1%).

All SEE countries increased their production and reduced CPI inflation in the first quarter of 2006. Unemployment rates were almost the same as in 2005. External economic disequilibrium in the region was not significantly reduced neither in 2005 nor in the first quarter of 2006.

Monet June 2006


Table 9.1: Macroeconomic Indicators of SEE countries

Alb

ania

Bos

nia

an

d h

erze

govi

na

/Rep

ubl

ika

Srps

ka

Bu

lgar

ia

Cro

atia

Mac

edon

ia

Mon

ten

egro

Serb

ia

Rom

ania

2001 6.5 4.5 4.0 3.8 -4.5 4.0 5.7 5.0 2002 4.7 5.5 4.3 5.2 0.7 0.8 3.3 3.8 2003 6.0 3.5 4.3*** 4.3 2.2 1.5 2.5** 4.9*** 2004 6.0** - 5.8 3.8 - 3.1 7.0 4.5

Real annual growth rate

of GDP ( uin %)

2005 6.0** 5.2** 6.4 4.3 4.0** 4.1 5.9 5.2** 2001 6.5 12.2/-12.9 1.6 6.0 -23.2 -2.7 0.0 8.4 2002 2.0 9.2/-2.5 6.5 5.7 13.7 0.7 1.7 6.0

2003 2.7 2.0/-1.6 (Mar) 15.6 4.0 0.5 (Nov)

6.5 2.4 -3.1 3.1

2004 - 9.0 23.4 3.0 -12.7(Jan-Dec) 13.8 7.2 5.3

2005 3.0* 5.1 (Dec) 9.3 (Oct) 6.9 (Dec) 5.1 (Jan-

Dec)

3.7 (Dec) 7.0 (Jan-

Dec)

-21,2 (Dec)

-1.9 (Jan-Dec)

0.3 (Mar)

0.5 (Jan-Dec)

2.0 (Dec)

2.0 (Jan-Dec)

Annual change of industrial

production (in %)

2006 - 5.9 (Mar) 0.5(Jan-

Mar) - 5.8 (Jan-

Feb)

1.9 (Mar) 0.5 (Jan-

Mar)

3,0 (Mar) 4,4 (Jan-

Mar)

5.8 (Mar)

3.5 (Mar)

2001 3.5 3.2 4.8 2.6 1.2 24.0 38.7 34.5 2002 2.1 0.3 3.8 2.3 2.2 9.2 1.8 22.5

2003 3.3 0.3 4.7 1.8

-1.1 (Jul) 0.3 (Jan-

Jul)

6.1 (Dec) 9.9 15.3

2004 3.5 -1.0 (Dec) 4.0 (Dec) 2.7 (Dec) -1.9 (Dec) -0.4(Jan-

Dec)

3.2 (Dec) 2.4 (Jan-

Dec)

13.2 (Dec) 11.4 (Jan-Dec)

11.9

2005 2.0 (Dec) 4.2 (Dec) 6.5 (Dec) 3.6 (Dec) 1.2 (Dec) 2.5 (Dec) 17.2 (Dec)

8.6 (Dec)

Annual inflation rate (CPI

in %)

2006 1.5 (Mar) 5.1 (Mar) 6.6 (Mar) 3.0 (Mar) 3.0 (Mar) 2.8 (Mar) 13.8 (Mar)

8.4 (Mar)

Currency name Lek

Konvertibilna marka;

BAM Leva Kuna Denar Euro Dinar Lei

2006 (against €)

117,19 (Maj)

1.956 (Dec)

1.958 (Dec)

7.33 (Maj)

61.2 (April) - 87.5

(Feb)

34.453 (Maj)

National currency

(against €) Annual

change in %

-4.7 - - -1.1 -0.3 - 8.7 -1.6

2001 15.4 39.9/ 40.2 17.3 22.2 30.5 24.8 27.7 8.8 2002 15.8 42.7/ 38.2 16.3 22.3 31.9 23.7 31.3 8.4

2003 15.0 43.1/36.6 (Mar) 13.5 19.1 36.7 21.6 (dec) 30.2

(dec) 7.2

2004 - - 12,6 18.7 37.0 19.5 (Dec) 31.9 (Jul) 6.2

2005 14.4 (Dec) 44.0 (Dec) 11.0 (Dec.)

18.0 (Dec) 34 (Dec) 20 (Dec) 32.6

(Dec) 5.9

(Dec)

Unemployment rate (

in %)

2006 14.2 (Mar) 47.5 (Feb 06)

10.4 (Mar)

18.1 (Mar) 37.3 (Feb) 18.3 (Mar) 33.0

(Feb) 6.3 (Feb)

2001 -22.6 -74.9 -11.7 -5.9 -15.3 -31.3 -28.8 -13.2 2002 -17.5 -79.7 -10.2 -11.1 - -24.9 -33.4 -8.6 2003 -21.5**** -81.3 -12.5 -8.0 -21.0 -24.2 -27.8 -8.9 2004 -23.0 -74.6 -8.5 -7.3 -21.7 -17.5 -27.0 -9.1

Trade Balance ( as % of

GDP) 2005 -21.5 - -19.3 -6.7 -22.5 -19.2 -26.8 -5.5 2001 -5.3 -25.3 -7.5 -3.7 -6.9 -15.7 -9.7 -5.9 2002 -9.5 -30.5 -5.6 -8.6 -9.4 -12.6 -13.0 -4.5 2003 -8.5**** -36.4 -9.2 -7.1 -3.0 -7.1 -12.0 -4.6 2004 -7.2 -34.1 -8.5 -5.1 -7.7 -7.8 -11.0 -6.6

Current account

deficit (% of GDP)

2005 -6.0 - -14.5 -6.3 -1.7 -8.6 -10.2 -4.8

Sources: Data for Montenegro are from ISSP database Data for other countries are from their central banks and statistical officies *Estimated by ISSP **www.cia.gov; ***www.inss.ro


68


Unemployment rates30 in the countries of the region were lowest in Romania (6.3% in February 2006), Bulgaria (10.4% in March 2006), Albania (14.2% in March 2006), Croatia (18.1% in March 2006) and Montenegro (18.3% in March 2006). On the other hand, Bosnia and Herzegovina, Macedonia, and Serbia continued to have the highest unemployment rates in the region, which amounted to 47.5% in Bosnia and Herzegovina, 33% in Serbia, and 37.3% in Macedonia in February 2006. Exchange rates fluctuation in the first quarter of 2006 was almost the same as in the second half of 2005. The Croatian Kuna appreciated a bit against the Euro after intervention of the Central Bank at the foreign exchange market at the end of 2005. The Romanian Lei also appreciated in the first quarter of 2006 after depreciation at the end of 2005 as a result of the higher seasonal demand toward the national currency, as well as intervention of the Central Bank at the foreign exchange market in order to stop further appreciation of the Lei, which had an impact on growth of the trade balance deficit. The Dinar, as the official currency in Serbia, stabilized somewhat in the first quarter of 2006, but it is still in a negative trend vis-à-vis the euro. This is mostly a consequence of the internal factors in Serbia and represents one of the sources of inflation. The Bulgarian Lev (BGN) is pegged to the Euro at the fixed exchange rate of 1.956 BGN per EUR. However, there is some medium-term currency risk because of a new “all-time high” estimated current account gap (as a % of GDP) in 2005, the lowered FDI coverage ratio, the spike in consumer price inflation, and the rise in gross foreign debt (as % of GDP). The Convertible Mark (BAM) in Bosnia and Herzegovina is also pegged to the Euro, and while the Euro is the official currency in Montenegro, there is no currency risk in these two countries. Current account deficits (as % of GDP) increased in almost all SEE countries in 2005. The current account deficit as % of GDP was the lowest in Macedonia (2% of GDP) and the highest in Bosnia and Herzegovina (around 45%) in 2005.

30 Unemployment rates within the SEE countries are calculated through the implementation of different methodologies and thus data on unemployment rates cannot be completely comparable, despite the fact that these are the only available data.

Monet June 2006


CHAPTER 10. INFORMATION COMMUNICATION TECHNOLOGY IN MONTENEGRO

Development of a telecommunication market in Montenegro is very similar to that of other developing countries in the region. The most important indicators show positive trends in comparison with previous years. Table 10.1. Telecommunication market in Montenegro

2001 2002 2003 2004 200531

Revenue of telecommunication market (in mill euros) 89.2 150.6 162.7 170.2 Total number of fixed lines users (in 000) 184 190 188 185 Total number of mobile lines users (in 000) 356 445 420 483 558 Total number of fixed and mobile phone users (in 000) 540 635 608 668 Penetration of fixed telephone lines 28.4 28.6 28 29 Digitalization 87 92.5 98 99.8 Penetration of mobile telephone lines 53.9 67.4 62.7 78 90 Percentage of mobile phone users in total number of users 65.9 70 69 72.5 Number of Internet subscribers (in 000) 18 27 37 51 61.2 Number of Internet users (in 000) 18 27 83 100 Internet penetration 2.6 4.1 12.5 16.1 19.5 Number of Internet service providers 1 2 2 2 2

Source: Agency for Telecommunications, Annual Report 2004 The telecommunication market of Montenegro increased from 2001 to 2005. Accordingly, total revenue of the telecommunication market increased by 90.8% in the observed period. The total number of fixed telephone lines was the highest in 2002 (190,000 users). The number of mobile phone users increased by 56.7% from 2001 to 2005. Internet penetration was at 19.5% in 2005, as compared to just 2.6% in 2001.

Graph 10.1. Revenues according to segment

43%

55%

2%

Fixed phones Mobile phones Internet services

Source: Agency for Telecommunications, Annual Report 2004 MOBILE TELEPHONY IN MONTENEGRO There are two mobile phone operators in Montenegro: ProMonte GSM and Monet. ProMonte was established in 1996, while Monet was established in 2000.

31 Observed period January-November 2005.


70


The number of mobile phone users has increased from 3,931 in 1996 to 558,000 in 2005. The number of prepaid subscribers in the period of 2000 to 2005 increased from 181,584 to 449,133 subscribers.

Graph 10.2. Number of mobile phone subscribers from 1996-2005

0

100000

200000

300000

400000

500000

600000

1 2 3 4 5 6 7 8 9 10

Source: Agency for telecommunications Calculation: ISSP

Mobile phone penetration, which represents the number of mobile phone subscribers per 100 inhabitants, increased from 9.4% in 2000 to 90% at the end of 2005. With this penetration, Montenegro is the leading country in the region and is at the same level as the Scandinavian countries. Mobile phone penetration in Montenegro is 20% higher than the average level of mobile phone penetration in Europe.

Graph 10.3. Mobile phone penetration in 2005

0

10

20

30

40

50

60

70

80

90

Mont

eneg

ro

Slove

nia

Euro

pe

Bulga

ria

Croa

tia

Rom

ania

Mac

edon

ia

Alba

nia BIH

Source: ITU Calculation: ISSP

Monet June 2006


Mobile telephony in 2001

At the beginning ProMonte GSM had 3,931 subscribers. From that point on, the number of subscribers has constantly increased and was at 62,306 in 1999. With the entrance of competition, ProMonte implemented a category of prepaid subscribers, which represented 57% of their 181,584 total subscribers in 2000 and 80% of their 258,929 total subscribers in 2001. The total number of mobile phone subscribers in the first year of Monet’s establishment was 59,861 (41,708 prepaid and 18,153 postpaid). The entrance of a second mobile phone operator created, not only increased competition, but it also increased the level of mobile phone penetration. The level of mobile pone penetration at the end of 1999 was 9.4% and at the end of 2001 it was 53.9%. The main reason behind the increased number of users is most likely the implementation of new services and the decrease of prices. Additionally, the competition influenced an increase in signal coverage as well. ProMonte GSM covered 96% of the territory and Monet covered 94%. In 2001, ProMonte dominated over Monet in both market segments (prepaid and postpaid mobile phone subscribers). Mobile telephony in 2002 At the end of 2002, the number of active mobile phone subscribers was 445,040, which represented penetration of 67%. That level of penetration was one of the highest when compared to other countries in the region, and was near to the average level of mobile phone penetration in the EU. The number of mobile phone subscribers in 2002 was higher (by 88,846 new subscribers) than in the previous year. The increase in that number was influenced by the entrance of a new mobile phone operator in 2000. Competition on the market increased the number of subscribers and influenced the implementation of new services. The most important service that was implemented was the SIM card, which was very popular. The total number of prepaid users doubled in 2002, as compared to 2001, while the number of postpaid subscribers decreased. At the end of 2002, the share of prepaid subscribers in total number of subscribers was 83.6%. ProMonte GSM and Monet covered 97% of the territory of Montenegro. ProMonte covered 81% of the territory with a signal higher than -95dBm, while Monet covered just 64% of the territory with this signal strength. The structure of calls going from Monet to ProMonte was at 60%, while calls going from ProMonte to Monet were at 50%. Both operators had a dominant share of calls within the country (more than 90%). The number of calls in 2002 was 312,316,809 at ProMonte and 243,627,262 at Monet. With regards to roaming partners, ProMonte GSM was in a better position with 134 signed commercial contracts in 67 world countries at the end of 2002, while Monet had 80 commercial contracts in 53 world countries. Mobile telephony in 2003 The total number of mobile telephone subscribers at the end of 2003 was 420,338, which represents a decrease of 5.5% comparing with 2002. That number represents 68%


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penetration, which was above the average of the country candidates for the EU, where the average level of mobile phone penetration was 43%. The decreasing level of mobile phone subscribers may be explained with market saturation. The number of prepaid subscribers was 8.2% lower at the end of 2003 than in 2002, while the number of postpaid subscribers increased by 7.5%. Among the total number of mobile phone subscribers in 2003, 81% were prepaid and 19% were postpaid subscribers. Even though the number of mobile phone subscribers decreased, the total number of calls increased in 2003 as compared to 2002 and totaled 347,186,230 minutes, an increase of 13.9%. Additionally, the number of sent SMS increased 32% in 2003 as compared to 2002. In 2003, the number of ProMonte subscribers decreased by 8.8% in comparison with previous year. In the same period, the number of Monet users decreased by 0.8%. ProMonte increased its outbound calls by 2.6% and Monet increased its outbound calls by 33.1%. Mobile telephony in 2004 The total number of mobile phone subscribers at the end of 2004 was 483,000, which represents an increase of 15% as compared with 2003. At this subscription rate, the penetration level is 78%, which is very near to the average of EU countries (average penetration rate in EU25 was 83%). The greatest increase in subscription rate in 2004 occurred in the category of prepaid subscribers (a 16% increase), and they increased their relative share in the total structure of subscribers. One of the factors that determined the high growth rates of the telecommunication and mobile phone market was the implementation of innovative services and flexible prices. Competition increased the level of signal quality and coverage area. According to the operators, ProMonte GSM covered more than 98% and Monet covered a full 98% of the territory of Montenegro. The total level of communication in mobile telephony in 2004 was 376,501,374 minutes, which represents an increase of 8% as compared to 2003. The structure of calls from Monet to ProMonte was 33% and from ProMonte to Monet was 26%, which is a reasonable result given the difference in the number of subscribers. Within both companies, the dominant share of calls is made inside the network (more than 50%). For ProMonte, the level of outgoing calls in 2004 was 206,441,426 minutes, while for Monet, this totaled 170,059,948 minutes. SMS messages show an increasing trend, with an increase of 43% in comparison with the previous year. Market share with respect to revenue in 2004 was ProMonte 60% and Monet 40%.

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Table 10.2. ICT indicators comparison (Mobile telephony)

MOBILE TELEPHONY

Country

Total number of

mobile phone

subscribers (000)

Number of mobile phone subscribers (per 100

habitants)

Rate32 (%) Prepaid

subscribers (%)

Population coverage

(%)

Mobile telephony/telephone users (%)

Albania 1,100.00 35.80 216.20 97.40 90.40 81.20 Belorussia 2,400.00 24.36 152.30 87.00 26.70 Bosnia 1,050.00 27.40 111.40 66.60 90.00 52.80 Brazil 65,605.00 36.32 34.30 80.50 60.80 Bulgaria 4,730.00 60.41 68.30 65.20 99.30 63.10 China 334,824.00 25.49 50.50 21.40 51.70 Romania 10,215.00 45.85 49.80 63.90 98.00 69.90 Serbia and Montenegro 4,730.00 44.96 50.80 84.30 38.00 63.80 Montenegro 558.00 90.58 NA 83.50 90.00 69.58 Macedonia 776.00 37.23 99.80 85.10 59.60 Ukraine 13,735.00 28.52 129.30 92.00 53.10 Argentina 13,512.00 35.35 28.60 88.00 60.80 Croatia 2,553.00 58.37 71.50 82.40 98.00 57.70 Czech Republic 10,771.00 105.33 40.80 71.80 99.00 75.70 Estonia 1,256.00 96.00 26.50 38.20 99.00 73.90 Hungary 8,727.00 86.43 39.90 73.10 99.00 70.90 Lithuania 1,537.00 67.22 41.10 56.40 97.20 70.90 Latonia 3,422.00 99.29 59.40 50.80 100.00 80.70 Poland 23,096.00 59.91 42.30 54.40 99.00 58.60 Russia 74,420.00 51.61 122.30 49.70 Slovakia 4,275.00 79.39 45.10 57.20 99.00 77.40 Turkey 34,708.00 47.99 33.70 75.90 95.00 64.50 Andorra 52.00 61.63 26.00 59.60 Australia 16,449.00 82.60 21.10 43.80 97.00 60.20 Austria 7,990.00 97.36 13.50 44.20 98.00 68.00 Belgium 9,132.00 88.32 23.40 66.10 99.00 65.80 Canada 14,984.00 47.21 16.70 18.70 39.70 Cyprus 641.00 79.37 33.40 49.80 100.00 60.50 Denmark 5,166.00 96.10 14.50 27.10 59.80 Finland 4,988.00 95.63 8.80 5.00 99.00 67.80 French 44,552.00 73.72 15.80 38.50 99.00 56.80 Germany 71,316.00 86.42 24.90 50.50 99.00 56.70 Greece 11,044.00 100.61 23.10 65.90 99.60 68.20 Island 291.00 99.44 11.00 42.70 99.00 60.50 Ireland 3,780.00 93.49 17.60 75.00 99.00 65.20 Israel 7,188.00 104.74 20.10 33.90 97.00 70.60 Italy 62,750.00 108.19 15.70 90.90 99.80 70.70 Japan 91,474.00 71.58 10.00 2.90 99.00 60.90 Luxemburg 539.00 119.38 26.70 58.80 98.00 60.00 Malta 306.00 76.52 52.10 92.40 99.00 59.70 Holland 14,821.00 91.34 17.10 68.10 99.50 65.30 Norway 4,163.00 90.89 11.00 42.50 65.10 Portugal 10,362.00 98.41 17.30 79.30 99.00 71.00 Singapore 3,861.00 89.47 18.80 32.30 100.00 67.40 Slovenia 1,739.00 87.09 28.80 49.90 99.00 68.20 Spain 38,647.00 89.46 20.80 51.90 99.00 68.30 Sweden 9,302.00 103.22 12.50 56.80 56.20 Switzerland 6,275.00 84.63 15.50 39.60 100.00 54.40 UK 61,091.00 102.16 17.60 66.70 99.00 64.40 USA 181,105.00 60.97 16.00 6.00 99.00 50.40 World average 1,751,940.00 27.43 28.90 46.30 81.50 58.50 Europe 573,417.00 71.30 25.90 62.10 96.70 62.00

Source: ITU, Agency for telecommunication

32 For period1999-2004.


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March 2006 By the end of March, the total number of mobile phone users was 548,120, which represents penetration of 88.4%. The total number of prepaid users was 445,852 and postpaid users totaled 102,268. In total, ProMonte had 329,376 users and Monet had 218,744.

Graph 10.4. Structure of mobile phone users

60,1%

39,9%

ProMonte Monet

Source: Agency for telecommunications By the end of March, the total number of registered SMS was 40,144,269. ProMonte had 68.4% of these and Monet had 31.5%.

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RESEARCH


76


PAYMENT FEES Authors: Jelena Janjušević, ISSP

Anja Vrandečić, ISSP INTRODUCTION Reform and continuous development of payment system represents one of the most important tasks of every state. Payment system presents “circulation” of total financial and public sector which should enable fast, secure, reliable and effective resource transfer between the participants of payment system. Central Bank Law adoption in November 2001 was a first step in payment system reform in Montenegro. Payment system transactions have been made by special state institution Agency for Payments and Settlement (hereinafter referred to as ZOP) thus state managed and controlled channels and money flows to the great extent. Main lack which needed to be eliminated by reform process is existence of monopoly in the payment system. The reform entails substitution of one institutional framework with another or changing some rules of the game with some other, which demands clear definition of transformation goals. Success of payment reform for its end users depends on new institutional solutions and reform bearer’s capability to create cheaper and more efficient payment system. Main task of this research is to determine reform goals, evaluate if and to what extent has the reform simplified the transactions and made them cheaper. Has the payment system reform or elimination of monopoly in payment system affected reduction of the transaction costs to the clients and thus increased overall system efficiency? In time of computerization and globalization is it to be expected to see increase or decrease of pay system services price? Is it to be expected to have higher or lower barriers? FUNCTIONING OF THE PAYMENT SYSTEM Market transactions are followed by certain transaction expenditures. Lower transaction expenditures imply faster, more efficient and cheaper transactions and resource transfer from inefficient to more efficient usage. On the other hand, high transaction expenditures limit the participants in exchange and are forcing them to find solution and a way out through gray economy channels. In situation when there are transaction costs, financial partakers are forced to spend resources in order to complete transaction which leads to decreased benefit of transaction itself and that can inhibit transactions. If the situation was different or if we didn’t have these expenditures then the property rights disposal would be different. Transaction costs influence resources allocation and lead to wealth redistribution. If we have lower transaction costs, we will have faster, more efficient and cheaper transactions and based on that resource transfer from inefficient to efficient manners of use.

The payment system implies transfer of money from the account to the account, accounting and other alignments in payment system, as well as cash payments and payoffs. Both legal and natural persons are participants who conduct payment by issuing payment instructions for the bearer.

Basic element of the payment system affairs which affects the height of transaction costs for the end users is fee that they pay for payment services. Fee level is very important because individuals and companies allocate significant amounts of resources to pay for market

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transactions. Paying for realization of transaction leads to increase in its price and thus directly decreases all participants’ benefits. High transaction costs contribute to transactions inhibition. Basic characteristic of these expenditures is that they aren’t voluntary, but are obligatory for all participants on the market. How does the payment system in Montenegro function?

Scheme 1 presents money flow in payment system in Montenegro. Money goes from pay in person. That person pays money to commercial bank which includes fee on it. If the recipient owns an account at that bank than that is an internal transfer or account and in that case bank doesn’t include any fee. Nevertheless, there are banks in Montenegro which include certain fee level even on the internal payments. Beside internal there are external accounts such are RTGS which is related to quick payments and transactions above €250 and to state steered transactions and clearing which is related to transactions below €250. Therefore, money is transferred to the recipient on one of the mentioned money accounts. Recipient comes to commercial bank where he has an account and bank charges him fee on paid off amount of money. So, in majority of cases, expenditure of transaction is paid by the person that pays in and the person that pays out money. Given scheme clearly shows that almost every transaction in payment system has been followed by certain expenditure (measured by fee height). In the following part of the paper we will try to review how much is the amount of expenditure and what kind of influence does it have on company’s business activity. PAYMENT REFORM IN MONTENEGRO One of the aims of the payment reform is to expand the services of Montenegrin’s commercial banks in credit and foreign currencies transactions with internal payment transactions and in that way provides to its clients full banking service in one place. Success of the payment system reform is measured by building of new institutional solutions and especially by the ability of

Scheme 1: Payment system in Montenegro

Pay in

PAY IN BANK

Internal

RTGS

Clearing

PAY OUT BANK

Pay out

CENTRAL BANK OF MONTENEGRO

Fee Fee

Fee

Pay out

Fee

Fee

Fee


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reform bearer to build cheaper and more efficient payment system. Has this goal been realized by reform of payment system in Montenegro? By monopoly abatement in payment transactions it was expected that competition among commercial banks will affect price decrease of payment services. It was also expected that payment reform will provide modern, high standard and cheap service for all clients as it was announced several times. Nevertheless, it had never happened. Overall payment expenditure in new conditions not that hasn’t been decreased but has increased. What is the manner for forming of fees for payment transactions? By Resolution on payment in the country33 and Resolution about Central Bank of Montenegro service fees for payment transactions in the country34 was defined a manner of payment transactions and Central Bank fees that are calculated to commercial banks for payment transactions. In other words, these Resolutions determine the manner of forming of payment tariffs. It is stated in the Resolution that the banks «can freely form theirs payment transactions tariffs». Central Bank has announced and conveyed the list of its chargeable fees to the commercial banks. Central Bank’s fees are the basis from which commercial banks calculates theirs payment transaction price. So, freedom of commercial bank is mainly limited by the Central Bank. Central Bank of Montenegro has introduced certain tariffs that haven’t been charged in the old payment system to commercial banks. Central Bank charges to commercial banks for cash pay in and pay out as well as for short term daily bank’s liquidity lends. Resources transfer from one to another client’s account has also been charged and that did not exist by the previous system. Resource transfers from bank’s calculating account to obligatory reserves account and vice versa has also been chargeable. Additionally, another way of increasing the costs of payment transaction has been introduces and that is the amount of fee conveyed to Central Bank after 14h00 is 30% higher. Can we talk about freedom of commercial banks in forming fees for market transactions? Has really payment monopoly been eliminated by ZOP elimination or it has just been transferred to different institution in current payment system – Central Bank? How is it possible that Central Bank had higher profit from aggregate profit of all commercial banks in 2005? Fees of the Central Bank are a base on which commercial banks add theirs earnings or additional fees. However, question is who is losing? Commercial banks? NO! Commercial banks will transfer their expenditure on the end user or individuals and companies in Montenegro. In this manner business environment becomes even more unfavorable and business development limitation is increased especially for small and medium businesses in Montenegro. The level of payment expenditure in Montenegro As we have mentioned before, commercial banks in Montenegro charge different fees for different payment transactions. Additionally, fee height is somewhat different from bank to bank and also certain client’s fees are different and that depends both from bank’s business policies and from size of the company. Next table shows detailed review of items with the fee in payment system. Fee range trend has been given because of the differences between banks.

33 Official Gazette of Republic of Montenegro, No 78/04 and 06/05 34 Official Gazette of Republic of Montenegro, No 78/04

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Table 1. Commercial bank’s pay market transaction fees in Montenegro

ITEM RANGE

Account opening No fee Account maintenance 0-1 € monthly

Account closing 5-10 € Internal cash pay in 0 – 0,5 € External cash pay in 0,2%-1%

Cash pay out 0,2%

Non-cash pay in 0,10%-0,17%; 0,2 - 0,3 €

Non-cash pay out 0,12%- 0,35% Confirmation and transcript issues 5 € or 0,50 € per page

E BANKING

Payments35 0,07 - 0,20 € Clients E-banking connection 25 €

Monthly payment for E banking service 0.50 € per page

Source: Commercial banks in Montenegro Following text will provide comparison of fee height in Montenegro with countries in the region. Regional comparison is important because it gives us more realistic picture. Comparison is presented in following table: Table 2: Regional comparison

Account opening

Account closing

Cash pay in

Cash pay out Non-cash pay in Non-cash pay

out

CROATIA 0 2.73-13.6 € 0-0.25% 0-0.25% 1%36 0 - 0,5€

BOSNIA & HERZEGOVINA 0 0-7€ 0 – 0.75% 0.13-0.68 €;

0.20 – 0.40% 0.10%-1% 0.5% - 2%

MACEDONIA n/a n/a 0.12 € - 1% 0.29-0.35% n/a 0.10%

SERBIA 0 0 0.4%-1% 0.50% 0.10 %m37 0.25%38 0.10 % - 0.80%

BULGARIA 0 0 0-0.20% 0.2%- 0.3% 0.1%-0.3% 0.2%-0.4%

SLOVENIA 0 20 € 0.17%-0.23% 0.19%-0.23% 0.06 – 2.7 € 0.32-0.62 €

MONTENEGRO 0 5-10 € 0.2-0.5% 0.20% 0.10% -0.58% 0.17%-0.35%

Table shows that fee height in Montenegro is, by most of the items among the biggest in the region. If we take cash pay in fee in Montenegro, they are among highest after Macedonia and Serbia. Similar situation is also with non-cash pay in, where only Croatia and Bosnia and Herzegovina are before Montenegro. Slightly better situation is with cash pay out fee where tariffs in Montenegro are among the lowest in the region. However, it is important to realize that differentiation of fees in our country is less important as well as the difference from the countries in the region. Much more important question is how business can stand that king of ballast and expenditure. There is space for decrease of these expenditures. Lower expenditures mean more freedom as on money market thus on capital market. Foreign banks arrival should enhance the competition. Additionally, new technologies and implementation of new payment instruments will affect further expenditure decrease.

35 This channels payments have a tariff with 25% discount rate regarding official tariffs 36 For amounts from 3.5 till 100 Croatian Kuna’s (in other words from 0,5€ to 13.5€) 37 For amounts from 10 to 500 Serbian Dinar’s (in other words from 0,10 - 6€) 38 For amounts over 500 Serbian Dinar’s (in other words over 6€)


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RESEARCH ON PAYMENT EXPENDITURES FOR ENTREPRISES IN MONTENEGRO All types of transaction costs and especially payment expenditures have great influence on business activity of the companies. Basic element of payment affairs that affects transaction costs of the end users is payment service fee. All commercial banks in Montenegro charge fee for internal payment services and its height, on overall Montenegro’s banking sector level has been shown in the previous part of paper. However, it often happens that banks have different fee policy towards certain companies. That is why we have conducted a research among Montenegrin companies in order to deduce payment costs and theirs share in overall expenditures of Montenegrin companies. Besides, aim was to ratify business familiarity with the reform of payment system and their satisfaction after second year of implementation. That’s why results from this research that has been conducted among 50 Montenegrin companies from different sectors and different parts of a country will be compared with 2005 research results when payment system has been officially transferred from ZOP to the commercial banks. Four years after initiation of Montenegrin reform of the payment system companies haven’t still been completely familiar with it. Namely, according to information gathered by the research, majority of companies (45.3%) have been partly informed about reform, 17% hasn’t been informed and 11.3% have been well informed. Companies mainly have more than one account with different banks for payment transactions. Namely, 69.8% of companies have more than one account – 30.2% have two accounts, 28.3% three and 11.3% more than three accounts. Research has shown that the biggest percentage of surveyed companies pay fee on non-cash transaction in range of 0.2-0.5% (48.8% of companies), than in range of 0.05-0.2% (39.5%) and the smallest percentage of companies (4.7%) pay less than 0.05% fee. In cash transactions area, majority of companies (53.1%) pay fees in range of 0.05-0.2%; equal percentage of companies (21.9%) pay 0.2-0.4% range and more than 0.4% while only 3.1% pay less than 0.05% fee (3.1% companies). Regarding fees for payment system with Serbia majority (60%) pay in range of 0.4-1%, than in range of 0.1-0.4% (26%) and the rest of them (14%) pay fees higher than 1%. Regarding payment with abroad, majority (64%) pay fees in range of 0.4-1%, than 24% pay in range of 0.1-0.4% and the remaining part (12%) pay fees above 1%. It is very important to emphasize that significant number of company’s (in average 40-50%) didn’t know the answer on question regarding fee heights so induced percentages are related to the companies that have responded to the following question. According to 76% of companies, fees are high. By their opinion fee level which would be acceptable for theirs business should be less than 1% (70% of companies) for internal payment while others consider 0.1-0.5% range as acceptable. Situation is slightly different when it comes to payment to abroad and Serbia. Thus, 82% of companies consider that acceptable payment fee to both, Serbia and abroad would be in the 0.1-0.5% range. Majority of surveyed companies (70%) think that pay market system transaction became more efficient and cheaper after ZOP abatement. Nevertheless, 60% of companies think that payment transactions are more expensive after its abatement.

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The research has shown that the companies allocate significant amounts for payment system expenditures. So, in 2004 68.8% of surveyed companies have allocated up to €5.000 per year, 12.5% of companies have allocated even more than €15.000 (given figure goes up to €85.000 in certain companies). Remaining companies have allocated from €5.000 to €15.000 for induced expenditures in 2004. Similar situation was also in 2005. Majority of surveyed companies induced €5.000 (69%) per year as theirs payment fee expenditures; hence 18% have allocated over €15.000 (but this figure goes up to €140.000 in certain companies). Remaining part correlates with €5.000 to €15.000 range. In following table are shown payment transactions expenditures in overall expenditures and incomes of surveyed companies during 2004 and 2005. It is interesting that during 2005 comparing to 2004 there has been increased number of companies in which these costs share in overall expenditures apropos overall incomes is in 1-5% range and especially this growth has been uttered when it comes to more than 5% share. So in 2004, at 20% of companies induced share in overall expenditures was in 1-5% range. In 2005 there were 28.2% companies that have had that range of overall expenditures share. Regarding share above 5% in 2004 we have had 10% of companies while in 2005 we had 10.3% of those companies. When it comes to incomes especially is emphasized increase of number of companies in which payment expenditures are higher than 5%. Namely, in 2004 there haven’t been those kinds of companies while in 2005 there were 5.7% of those companies. Percentages do not seem high at first sight, though if you consider that average yearly company’s expenditure is from several thousands to several million of Euro than 1% or even 5% can’t be negligible. It is also very important to notice that fee shares in overall expenditures are up to 10% apropos 25% (in 2004 and 2005, respectively) while incomes are concerned inducted percentage comes up to 5% apropos 15% (in 2004 and 2005, respectively). It is interesting to mention that the percentage share as in expenditures thus in incomes is much higher in 2005 than in 2004. If we compare given payment expenditure data to companies' profit we could observe that those are quite high ratios. This is shown in the following table and relates to 2004 and 2005.

If we compare these results with the results of the research conducted in previous year we can see that there wasn’t any payment expenditures decrease in companies overall expenditures. Last year’s research has shown that in majority of companies (89%) fee expenditures have had participated in overall

expenditures with less than 1%. According to this year’s research number of those companies in 2005 has been decreased (61.5%) while percentage of companies with higher payment expenditures share in overall expenditures has been increased. Thus, in previous research we have had that percentage was in range of 1-5% at 5.6% of the companies; and at he same percentage of companies (5.6%) inducted share was in range of 5-10%. According to the last research number of companies with inducted payment share in overall expenditures has been significantly increased and it’s 28.2% apropos 10.3%. Situation is similar with incomes. In the previous research, in the majority of companies, ratio between payment expenditures and overall income was less than 1% (81.3%) while at 18.8% of companies inducted ratio was 1-3%. None of the surveyed companies had ratio higher than 3%. Results of the last research are significantly different. Percentage of companies with less than 1% ratio between payment costs and overall income is 71.4%; in 22.9% of companies inducted ratio is in 1-5% range and at

Table 3: Fee expenditures share in companies overall expenditures and incomes

2004 2005 Fee height % in expenditures % in incomes % in expenditures % in incomes

less than 0.5% 30 39,3 28,2 40 0.5-1% 40 32,1 33,3 31,4 1-5% 20 28,6 28,2 22,9 more than 5% 10 0 10,3 5,7

FEE HEIGHT 2004 2005

less than 1% 28% 34,4%

1%-5% 12% 28,1%

5%-10% 16% 18,8%

10%-20% 28% 9,4%

more than 20% 16% 9,4%


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5.7% of companies ratio is higher than 5% (in certain companies those percentages go even up to 15%) CONCLUSION Based on all above inducted it should be expected that if banks don’t change fee policies soon, payment service fees will represent one of the major banks’ profit sources and significant expenditures for business subjects. Only healthy competition between banks in internal payment system can lead to promotion of quality service and to fee change. Only than payment system can be expected to become more efficient and cheaper for its end users. It is necessary to give more working space to Montenegrin companies in order to help them survive. High tax and custom burdens, complicated procedures, high transaction costs – mainly fee costs, days of waiting, etc. represent a clamp for Montenegrin companies and their development. No subject thus no company can survive in chains. They will stifle or try to find an exit in avoidance or gray economy.

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\

ANALYSIS


84


THEORETICAL APPROACH TO PROGRESIVE TAXATION Author: Jadranka Kaludjerović, ISSP

“Taxes are necessary. But the system of discriminatory taxation, which is universally accepted

under the misleading name of progressive taxation, of income and inheritance is not a mode of taxation. Rather, it is a mode of disguised expropriation of successful capitalists and

entrepreneurs.” Mises, The Human Action

Understanding each economic problem begins with understanding its core truth and meaning. Therefore, in order to understand the possibilities of introducing a flat income tax we have to understand the essence of taxation and the nature of income tax. This question especially occupied members of the Austrian school of economics, who conducted a compressive analysis of the taxation issue. What is taxation? Taxation is the expropriation of property. By taxing property that belongs to businesses and individuals, money is transferred to the state, i.e. to the Government. Why does expropriation happen? Expropriation exists because the Government has certain costs that must be covered. If the Government cannot create value (money), they have three possibilities to cover their expenses: o to print money, o to borrow money from the private sector (to take a loan); o or to take money from the private sector. The least costly option for the Government is to simply take a portion of the money (value) from those who create it and use it to cover their expenses. In this way, money is transferred from producers to non-producers. Additionally, by doing this, individual freedom of choice is changed by Government choice. Government spending cannot be analyzed separately from taxation because they are two sides of the same coin. What are the implications of property expropriation? Suppose that the Government collects taxes in the amount of 2000€ from individuals who planned to use this money to buy jewels and the Government then spends this money on paper. On the market, the demand for jewels is now transformed into the demand for paper. A lower demand for jewels means a lower price of jewels, while a higher demand for paper means higher prices of paper. Simply, this means that resources are transferred from the sector of jewels production to the sector of paper production. For example, this may lead to an increase of wages in the sector of paper production and a decrease of wages in jewels production. In addition, each of these sectors is connected with other sectors (material of machine suppliers, etc) so that trends from the sectors of paper and jewels production are transferred to other sectors as well.

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The conclusion is that taxation changes the allocation of production factors, structure of goods produced at the market, as well as incomes. Actually, it is clear that taxation does not represent anything more than interference of the Government at the market. What happens when the Government taxes individual income? Individual income consists of wage, income from ownership, profit, interest, etc. The more that an individual is paying to the Government the less income they have for him/herself. A portion of the income that an individual has after paying taxes may be spent, saved, or invested. What portion of income does an individual spend and what portion is saved depends on his preferences; does the individual prefer consumption or saving? With the increase of real income the time preference ratio decreases (the ratio between consumption and investments). Taxation implies the lowering of the real income of individuals. Because of that, the time preferences of this individual are increasing. That is why this individual will consume more and save and invest less. This means that income tax not only decreases the total income of an individual, and by that consumption and investments on the macroeconomic level, but it also shifts the ratio between consumption and investments in a way that increases current consumption and lowers current savings and future investments. Why tax rates should be flat? We saw that the consequences of taxation include: o less individual freedom; o changed allocation of the production factors; o changed structure of goods produced on the market; o decreased income; o lower incentives for work and earrings; o lower savings and investment. Taxation, regardless of whether it is progressive or proportional, violates the free market. Higher taxes lead to a smaller free market. Because of this, the real challenge for all economists is to find out which tax is the most neutral, or which would have the smallest change on the distribution of income. Economists do not agree on the best solution; some favor a neutral rate, some a uniform tax, while others favor taxation based on some other principle (such as benefits, costs, voluntary, etc). However, most economists of liberal orientation agree on one thing, and that is: Progressive taxation is the most unacceptable form of taxation. Progressive taxation means higher tax rates for individuals who earn more. One simple question arises: Why should those who earn more be taxed more? Let’s remind ourselves how individuals earn their income? They earn their income by selling their services or goods to employers of customers. The individuals who earn the most are those who have the greatest knowledge of what was sold to employers, those who were the hardest working, and those who succeeded in satisfying the needs of most consumers. In a progressive system of taxation, they are the ones that are paying the highest taxes. They are punished because they were hard workers and good entrepreneurs. However, it is usually forgotten that it is not only them who are punished, but their customers, buyers, and employers are punished as well. Hard working individuals who earn the most will


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not be motivated to work as hard or to be as successful if they are taxed in this way and this will influence the level of goods and services offered at the market. On the other side, consumers will not be able to satisfy all of their needs because of the decreased offer of particular products and services. All of these processes, analyzed at the level of the overall economy, translate into a lower standard of living for citizens. Progressive taxation not only punishes the best of us but punishes all of us by lowering our freedom of choice and our living standard. Does progressive taxation represent “robbery of the rich by the poor”? No! For example, if a poor individual pays 1 € of tax and a rich individual pays 10 € of tax, all individuals in the society are paying taxes, both the rich and the poor – all except for the state that is. Progressive taxation does not represent robbery of the rich by the poor, as both pay taxes. Progressive taxation, the same as any other form of taxation, represents the robbery of both the rich and the poor by the state. In any society, the state is the only subject that is not a taxpayer but a tax consumer. How important is the level of tax? The tax level is one of the most important issues of the tax system, an issue that is even more important than the model of taxation. The reason for this is that lower taxes make small disturbances to market relations. Or in other words, income distribution in a system of low taxes is most similar to income distribution on the free market. Therefore, we may conclude that the best tax system is the one in which the tax rates are lowest. Or, as public spending and taxes are two different sides of the same coin, the best system of public finances is the one in which Government costs are minimal. LITERATURE

1. Mises, Ludwig von (1996), Human Action: A Treatise on Economics, San Francisco: Fox & Wilkes.

2. Rothbard, Murray N. (1995), Making economic sense, Auburn, Alabama: The Ludwig von Mises Institute.

3. Vukotic, Veselin (2002), Makroekonomski racuni i modeli, Podgorica: CID

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FLAT VERSUS PROGRESSIVE TAX FROM THE VIEW OF EQUITY Author: Nebojša Obradović, ISSP

In the field of engendering and extension of economics integration we have to overcome a lot of barriers and compare the advantages and disadvantages of integration trends on the national economy. It is certain that tax policy has a specific and very important role in this process – it can represent a barrier or it can be an element that enables, improves, and acelerates it. Taxes are inevitable. Therefore, it is not surprising that identification of a tax system is the object of many debates and disputes. By their nature, taxes are always destorzive, enter masses and costly to the economic process, and that is why they always have a negative connotation in the market economy. Taxes represent the most important instrument of fiscal policy. Knowing that taxes have a significant impact on our lives, it is hard to choose one specific system of taxation. Therefore, all economic research on taxation attempts to find which taxation system does the greatest or least damage to the economy. As a starting point, the economic research uses different aspects of the tax system, such as equity, efficiency, flexibility, political responsibility, administrative simplicity, etc. A very frequent debate on the tax system is the debate on the fairness of tax systems. Although everyone agrees that a tax system has to be fair, there are many debates as to what fair means and how it can be estimated. This essay provides an overview of flat and progressive taxes from the perspective of fairness. How should the tax burden that is aimed at financing public goods and services among the population be distributed? What criterions and principals should we use to estimate the fairness of a tax system? PRINCIPLE OF UTILITY Many people accent utility as an argument for implementation of a progressive tax rate. The core belief of the principle of utility is that everyone has to pay tax in proportion to which they enjoy the benefits from public services. In other words, wealthy citizens should pay higher taxes as compared to poor citizens because wealthy citizens have more benefits. Let us consider some examples from Gregory Mankiw that were mentioned in his book “Principles of economics.” Example 1 – benefits of police protection from robbery: Citizens who have more property to protect in case of robbery enjoy higher benefits from police than citizens who have less property to protect. Therefore, according to the principle of utility, wealthy citizens have to assign more money for financing the expenditure of police services than do poor citizens. The same argument is used for examples of other public services such as fire protection, national protection, justice system, etc. However, the dilemma on whether wealthy citizens do indeed use more public services and goods still remains. Assuming that it is true, that wealthy citizens do use these services more, how can it be fairly determined how much more, what percentage, they should pay in taxes compared to poor citizens. Example 2 – tax on gasoline is sometimes excused by the principle of utility. In some countries, revenue from taxes on gasoline is used for construction and maintenance of roads. Since the people who purchase gasoline are users of the roads, the tax on gasoline can be seen as a fair way of paying for this public service. In this way, people who do not use the roads will be exempt from paying taxes, while everyone who does use the roads will pay taxes. Example 3 – program for poverty reduction financed from taxation of wealthy citizens. Generally, people prefer to live in a society without poverty, which means that programs for poverty reduction represent the public good. Provided that wealthy citizens value this public


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good more than citizens of middle-income levels, then according to the principle of utility, they have to pay higher taxes to finance this program. However, it is questionable whether wealthy citizens do value this public good to any greater extent than middle class citizens. What criteria are used to measure that? Generally, in the real world it is hard to implement the principle of utility because a market mechanism that can place a value on the benefits that each individual receives from public services does not exist. Additionally, implementation of this principal brings more anomaly into the tax system. For example, a tax on the usage of some public good could create lesser use of that good, which results in an ineffective allocation of resources. Further, that means that implementation of the principle of utility would bring about the presence of a trade-off between fairness and efficiency. PRINCIPLE OF PAYMENT ABILITY Another principle, which we use to assess the fairness of a tax system, is the principle of payment ability. This principle analyzes the fairness of taxation by the ability of the taxpayer to bear the tax burden. Principle of payment ability recognizes two concepts of fairness: vertical fairness and horizontal fairness. Vertical fairness considers that taxpayers with a greater ability to pay taxes should pay higher amounts. Horizontal equity considers that taxpayers if equivalent ability to pay be required to pay the same amount of tax. According to vertical equity, economically powerful citizens have to pay a higher percent of tax than less powerful citizens. While there is no dilemma that the tax burden should be determined on the basis of economic power, there is still the unsolved problem of how to determine how much higher of a percent should the economically powerful taxpayer have to pay, if they have economic power 5 or 25 times higher than economic power of another citizens. Is it necessary to implement a flat tax where everyone pays the same share of their own income, or to adopt a progressive tax where taxpayers with higher income pay a higher share of their own income? Another question to ponder is whether taxpayers should be taxed by applying the principle of horizontal fairness. If so, what should the tax amount be in that situation? A tax system is horizontally fair if persons who are equal in all relevant aspects are equally treated. However, this definition brings two dilemmas: what does being equal in all relevant aspects mean and what does equal treatment mean? Is it possible for taxpayers to be similar in certain criteria (age, sex, number of children, marital status, source of income, conditions of health, etc.)? What are the acceptable differences? Besides that, it is very important to see what people pay as taxes and also what they receive as transfer. In support of that is an example from practice – federal tax burden – progressive taxation (Gregory Mankiw “Principles of economics”). The conclusion learned from this example is that if we subtract the progressive tax rate from transfers, progressive taxation shows a higher progression. The richest citizens still pay one-quarter of their income to the state, even if transfers are subtracted. Conversely, the poorest families receive higher transfers compared to what they pay in taxes; so although the poorest families pay 5.3% tax, because of the transfers they receive, their tax rate eventually becomes negative and amounts to –30%. In other words, their income ends up being about 30% higher than their income without taxes and transfers from the Government.

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Criticism of income taxation is presented in the example of “Jon and his twin brother Jim” 39, whose capacity and education level are identical. Jon decided to work at the secondary school as a professor of economy. He has six hours of lectures every day, and in his free time he enjoys fishing, swimming, and yachting, and he is very happy. On the other side, his brother Jim chose to become an economic consultant and works 70 hours per week; he has no time for fishing, swimming, or yachting. With respect to what they are able to do, they have identical starting positions; namely, they have the same ability for earning. However, they made different choices and as a result of that they have different incomes. Should Jim pay a higher tax rate than Jon? Jon believes that income is an adequate basis for taxation, while Jim believes that the ability for earning should be considered instead of real income as an adequate basis for taxation. According to the principle of payment ability, Jim has to pay a higher tax rate than Jon. But, is that indeed fair? What happened with their capacity and education level? Do we need to implement a flat tax rate in this case? However, the problem is that the state does not have a mechanism that they can use to estimate the starting position of an individual. Therefore, in real life the state uses income or consumption of an individual, regardless of whether those measures may be an inadequate unit to measure the ability of payment. Hence, the principle of payment ability is used in real life, although it has a lot of disadvantages. CONCLUSION Considering the fact that public services must be financed from taxes, distribution of the tax burden among users of public services represents a problem. We must always ask ourselves do we fairly distribut the tax burden by applying the principles of utility and payment ability. Hence, depending on the point of view, today’s fair taxation may not be seen as fair for yesterday or tomorrow. Also, fair taxation in one state is not necessarily fair in another state. Similarly, fair is viewed differently depending on which perspective you are looking from; the point of view of an employer or producer will be different than the point of view of a consumer or an employee. Fairness is like any another judgment; it is not given once, nor is it forever. The question of the fairness of tax systems will always be posed as a means of improvement. Considering the complexity of the problems related to the fairness of the tax system, it is hard to give an answer that will facilitate choosing one type of taxation, and economy theory is not trying to give such an answer. Equity is like beauty; it is in the eye of the beholder. Of course, this does not mean that fairness of taxation should not be carefully considered. It will not be a neglected issue because politicians know very well how they will pass the elections if they neglect the fairness of taxation of the citizens-tax payers. LITERATURE 1. Economy of public sector, Joseph E. Stiglitz, 2004 2. Principles of economies, Gregory Mankiw, 2004 3. Tax sistem and tax policy, Bozidar Jelcici i Barbara Jelcic

39 Joseph E. Stiglitz “Economy of the public sector”


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FISCAL POLICY AND STATE’S COMPETITIVE ADVANTAGE Author: Ivan Jovetić, ISSP

PARADIGM OF COMPETITIVENESS Fiscal policy has always had the functioning of the state as its main goal. The specific use of those financial resources is a completely different question and marks the state’s dividing line regarding its role in certain economic trends and theories. The creation of an adequate fiscal policy is perhaps one of the last remaining aspects of any state’s economic policy in the era of globalization -- economic policy that has growth and development of the society and economy as a main goal. The second fiscal system bedrock is the belief that it symbolizes each state’s sovereignty -- but sovereignty in the purely political sense. Erosion of the second bedrock has begun with the globalization process, when even the notion of a national state lost its drift and significance. Nevertheless, sovereignty in an economic sense can be symbolized by fiscal policy. This is, of course, assuming that we can commonly speak about the sovereignty of economies and neglect all interdependencies that exist today. The most important part of fiscal sovereignty is the fact that it is one means of competition, on the international market, for the allocation of scarce resources. Competition doesn’t represent just a struggle with others, but with itself as well and it insists on all levels of economic freedoms40. Competition of one economy, apropos the state (macroeconomic competition), is based on micro level competition that is comprised of individual and economic freedoms41. There are, however, universal economic freedoms regarding the concept of human rights that no state mustn’t dared to violate. It is very important to realize that products and services that have been sold by companies from certain countries are not products and services of those countries but rather of the individuals that are operating their business in those countries. Towards understanding of economy or at least its attempt, the competition of one economy represents the competitiveness of the economic environment and its relation to business. A highly competitive economic environment will result in an increased quality of life for each individual. A precondition for an increased quality of life is growth in human labor and capital productivity. This is a new competitiveness paradigm42 and the time for believing in Ricardo’s comparative advantage theory is passing. Ricardo’s theory, which backs the branch development ideas, has been the perfect framework for state’s interventionism. In favor of the new paradigm, paradigm of productivity, are examples of very wealthy countries with modest traditional economic resources and unstoppable globalization processes as well. This paradigm predicts the creation of an adequate business environment regarding conditions of establishing, conducting and exiting business; the environment that is completely adapted to both domestic and foreign business. The basic obstacles to the creation of such an environment are the existing business barriers (costs of establishing, conducting, and closing a business are extremely high), high government consumption, and its inadequate structure. A fiscal policy that is adequate and favorable to both businesses and citizens can significantly contribute to the amplification of an economy’s competitiveness. Fiscal policy isn’t the only measure that the state can carry out with regards to reaching the common goals of citizens, businesses and the state itself. The creation of institutions and rules of law for the society that set initial equality of all citizens are also very significant processes. Competitive fiscal policy is perhaps more of a consequence of society’s mental transition rather than a mechanical

40 Veselin Vukotic, «Economic culture and competitiveness», Entrepreneurial Economy Vol. X, December 2005. 41 Veselin Vukotic, «Economic culture and competitiveness», Entrepreneurial Economy Vol. X, December 2005. 42 Veselin Vukotic, «Economic culture and competitiveness», Entrepreneurial Economy Vol. X, December 2005

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measure. A precondition for a competitive fiscal policy is change of the state’s role, change of areas that it is financing, and facilitates its complete withdrawal from the market. According to a liberal economic concept, the state should have a role in areas of science, culture, research and development, and however precisely targeted, social policy. Certain population groups such as the elderly, disabled, and sick deserve attention and should definitely be under the state’s care. Nevertheless, in social policy there is no place for those who are not willing to work or who do not earn as much as they think they should -- the social policy must not be ballast for business. Within the economy, citizens do not need social service but rather they need a job and the opportunity to increase the quality of life for their family through their own work. Only a sufficiently attractive environment can provide opportunities for all. It is possible to think about fiscal policy as an instrument of competitiveness, but not until the basic assumptions have been clarified. The belief that competitiveness on the foreign market requires assistance for different branches and sectors is an easily overthrown concept. Free international trade is an unquestionable concept incompatible with demands for sector support to ensure the product’s competitiveness. We must always keep in mind that each selection has a cost, especially the selection of a sector and an investment; in those, the cost is expressed as an increased tax burden for all of us individually, but also in the higher price of products and services. Additionally, we should be cautious when it comes to product “competitiveness”. Products and services that are produced in a high tax burden economy can’t be competitive on the world’s market because those products are increasing their production price. Therefore, the tax level and a product’s or service’s competitiveness are conversely commensurable. FISCAL COMPETITIVENESS STRATEGY The state is not an untouchable mythological creation, and because it is not, it must be adaptable to certain principles of competition. In that sense, it is very important for the state to formulate its own competitiveness strategy in order to reach adequate results. Taxable categories, tax rates and taxation manners, are the basic elements of the creation of a fiscal competitiveness strategy. The overall tax burden, including all types of contributions and tariffs, must be sufficiently attractive to businesses so that they can confidently create their own corporate strategy based on it without considering any other features of the economy. Globalization has made it imperative to decrease the costs of doing business. On the other side, the same imperative can be posted regarding the state. Despite the fact that certain states don’t realize or don’t want to realize this, it is a reality. Although the concept of low taxes is easily implemented in smaller economies, here it is essential that it can be in general applied everywhere. Montenegro, as a small economy that aspires to openness, must argue fiscal competitiveness in her competitive advantage concept. Although each economy should aspire to openness, the significance of the degree of openness is conversely proportional to the national economy size. A favorable fiscal policy is not the creator of competitiveness43. The real creators of competitiveness among products, corporations, or economies are science, technology, innovations, entrepreneurship, and education, and not necessarily in this order. Taxes as a competitive strategy influence the overall cost of doing business apropos job creation (new jobs) or loss (both existing and new!). Another very important strategy element to fiscal competitiveness is the simplicity of the tax system. This element is especially significant in the long term. Besides, Montenegro could use future potential high growth rates, lower incomes44 as compared with the rest of Europe, and quality human capital as well.

43 Stephane Garelli, Taxes and Competitiveness – Is there any link? – World Competitiveness Yearbook 2005, International Institute for Management Development (IMD), May 2005. 44 Similar concept has been applied in India especially in ICT sector.


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Business practice is often the best possible practice. The corporate world, among other things, recognizes “mammoth” and “gazelle” corporations. The first are enormous and inflexible corporations that respond to numerous obstacles with job cuts, decreasing income, and similar penalizing mechanisms. However, the number of employees is very often a result of a poor corporate competitiveness strategy. Does this sound like certain state behaviors, especially those states very close to the socialist model? On the other side, corporate gazelles represent small, open, flexible, and adaptable companies. This is undoubtedly applicable to states as well. Despite the mythological cognition of it, the state represents a social contract in order to protect individual rights. The state, like a business, has been formed by individuals and they are its focus. Does the high tax burden protect our individual rights? Would you like the chance to work and relish the protection of individual rights? One of the illusions that must be broken is that the state’s size is significant apropos her internal market. This illusion implies that foreign direct investments (FDI) would only come to a country with significant market potential, and in that case, a lot of investors would bypass Montenegro. However, the whole idea is in the size of the Montenegrin market. The tax burden represents one of the biggest and most often completely intangible business expenditures. Montenegro must rely on new investors who will only come if their business expenditure is lower in Montenegro than elsewhere in the region, or in Europe! If business costs are lower, domestic investors who are looking for their chance to own a business can be expected to increase their own investment in Montenegro. In order to become a business carrier in the region, Montenegro must boost exactly that approach45! Currently, there is no country in the region that could jeopardize Montenegro’s goal in encompassing the reform process. However, this doesn’t mean that things can’t change or that we have the luxury of a slow reaction. We must be aware that in today’s era of globalization, the big don’t eat the small, but rather the fast eat the slow46. The size of an economy in a global economy doesn’t have the same significance as it had in the past; in fact, the majority of richer countries today are relatively small economies. Why would Montenegro be an exemption? State alike business must determine who their direct competitors are. In other words, Montenegro has as its competitors other regional countries, but also the European Union countries. A lack of understanding of the principles of a basic liberal economy is had by a majority of the regional and EU countries, and this can only contribute to Montenegro reaching its final goal of wealth and an increased quality of life through an adequate strategy implementation process. Although Montenegro is expected along the European path, we have to pay attention to our European competitors. We have to succeed in our intentions to cut ourselves a piece of the cake, as other new EU member states have done, which isn’t a simple task. Some of their approaches deserve our attention; such as Estonia with a 0% corporate income tax in the case of reinvesting (24% is on distributed profit) or Slovakia with a 19% flat rate. Nevertheless, there is no reason that Montenegro in mid-term can’t become an even better example. The corporate income tax is 9% and implementation of the rate should begin47. Why can’t it be even lower? Isn’t it possible to achieve a 10% flat rate in mid-term? It probably is possible, but only after restructuring public consumption. So far tax policies have been moving in the right direction: introduction of one of the lowest VAT rates, future implementation of the lowest CIT, and realization of a small but significant decrease in the corporate tax burden48. Very important future steps are similar reforms on the local levels and the possible implementation of a flat rate on all personal income sources.

45 Veselin Vukotić, Conceptual basis of new economic system in Montenegro, ISSP, Podgorica, 2005. 46 Vadim Kotelnikov 47 Although legal rules introduce 9% CIT rate from January 2005. last year’s collection was made by 15% and 20% rates. This fiscal competitiveness strategy is a bad implementation example and must become just a warning. 48 Contributions are also part of doing business expenditure.

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TAX CONCEPT AND FISCAL COMPETITIVENESS INSTRUMENTS Fiscal competition, as among countries as inside of one country, represents an excellent mechanism for controlling politicians. The EU enlargement controversy about the fairness of fiscal competition is increasing because the new member states are using it as an instrument for self-positioning on the European market. Nevertheless tax harmonization (violent one) has a significant number of bystanders, especially in the old EU member states. A very simple reason for this is fear, not from the loss of potential income but from the loss of political power because the politician’s, and part of the voters’, eternal game will be over. Fear exists on central and local levels, although certain countries flourish on the central level regarding tax competition. Neither European nor Montenegrin local governments want or have enough sense to launch a (internal) tax competition process. In the tax competition concept, certain post-socialist economies reformers have realized the importance of eliminating as much as possible the state’s intervention in the economy. Undoubtedly, they’re (re)defining the concept and purpose of taxes. Taxes represent only the price of a certain favor (which should reverberate its quality), which in this case is provided by the state. The level of the tax should depend on service quality and not on the level of someone’s income. Imagine a situation where someone is selling a computer at a price that depends on the buyer’s salary level. Tax rate differences are necessary to ensure adequate public services that reflect quality, apropos as a politician’s behavior control mechanism. Any tax harmonization story, and even one from the EU, fails exactly on this test. For a particular service, there is a very interesting observation with respect to the price and quality of that service; and that is that one income tax rate does not represent the real proportional rate. The absolute tax obligation will increase as income increases; and that will happen in any case. The real proportional rate would really be a fixed price of different services (security, infrastructure, etc.), which wouldn’t represent a percentage of any amount. Nevertheless, it remains an open question on what level should that price be set in order to be acceptable for extreme parts of a society at the same time49. In any case, proportional taxes, even in the “wrong” variation, are closing as to the valuation of tax obligation like the price and quality of certain services as to the principle of fairness. Abatement of progressive rates and municipality surtaxes with higher tax income disposal decentralization would contribute to increased overall tax competitiveness and create a favorable business environment, all of which would lead to improved quality of life and increased individual wealth among families and society in general. A second very important matter is the introduction of a flat income tax rate. A flat rate represents the important elimination of the progressive income tax. It is very important to differentiate a flat rate from a single tax rate. The second one represents a replacement of purely various tax rates with a single rate and it is a narrower concept than a flat rate. On the other hand, the flat rate concept represents a wider change of the tax basis at which all types of income are taxed once at one tax rate regardless of whether an individual or a business generated the income.50 It is all about setting the income brink at a level that is low enough so as not to attract tax evasion. This system is very persuasive and based on consumption, which is perhaps one of the reasons why certain economies have eliminated VAT as a tax mode. A flat system impels investments because it enables automatically 100% tax exemption for investing and excludes saving returns (dividends and passive interest rates) from taxation. We should be aware that the flat rate has existed in all industrialized countries until the first half of the 19th century, apropos until Carl Marx and his Communist Manifesto in 1848. Although, we should also bear in mind that the capitalistic world accepted Marx’s demands for

49 I have heard first time for these ideas from Vladimir Gligorov during a conversation after lectures on Postgraduate studies Entrepreneurial Economy on Faculty of Economics in Podgorica. 50 Critical Issues Bulletin: Flat Tax – Principles and Issues, Fraser Institute, 2001


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heavier and more progressive taxation51. While actual tax systems now force taxpayers into high outlays to avoid losing time and backfilling their tax returns, the great world’s economies remain immune to the flat rate idea. Maybe it’s a coincidence or a game of history, but one of the initial impulses for the introduction of this tax system mode came from the east. In the 90’s, Estonia has accomplished a pioneering undertaking in the tax reform process, in what was until then a communist world. Basic flat system advantages52:

Simplicity This principle was introduced by Adam Smith and since then it has been considered as a valued component of each efficient tax system. Clear concept expression of overall tax system and adaptation and adjustment costs to its demands are considered under simplicity term. Simplicity implies the elimination of all exemptions, rejections, tax credits, and exclusions.

Efficiency There must be an adequate ratio between recollected resources and expenditures of the recollection. This system eliminates the additional cost that is added in order to adapt complicated system costs and that unnecessarily load business.

Fairness A great number of people believe that rich people should pay more and that that is the optimal concept of fairness. Nevertheless, a smaller number of people confess that the same situation is found in the flat system because the rich are paying the same amount in relative terms in the form of the same tax rate, while absolutely they are paying according to their financial strength. Here we reach the ideas about which Gligorov was speaking and which are originally Buckhannon’s ideas. Compared to others, this system is fairer with regards to the reward. Can we then commonly talk about the fairness of high taxation of the persecuted minority, as Ayn Rand used to call it? We should return to the benefit principle of the state’s services and that principle should be protected by the Constitution. The reason for creation of the state is the fact that she can and must provide adequate services to all its citizens. Although a flat rate definitely isn’t a cure for all of the problems of the economy, it has several other advantages53: o Decreases inequality in taxation (same rate for all)54 o Decreases tax evasion and tax frauds o Incites work, savings and investments o Leads to increased budget incomes o Eliminates almost all modes of tax exemptions and relief’s o Per se leads to a certain degree of growth in economic activity o Appropriate for shareholders and dividend recipients with profit being taxable only once, at

the corporate level o Eliminates special interest lobbing, which is responsible for the complexity of the tax o system o Providing significant tax free reimbursements, this system exempts the poor from o paying taxes o Enables individuals greater control over their own money and decreases the violation of o privacy by the government o Decreases interest rates as a result of interest rate income being tax exempt o Increases attractiveness to domestic and foreign investors 51 www.euractiv.com 52 Bruce Bartlett, NCPA Senior Fellow, Benefits of the Flat Tax, National Centre for Policy Analysis 53 Induced by: www.euractiv.com i Andrei Grecu, Flat Tax – The British Case, Adam Smith Institute, London, 2004. 54 Theoretically this system should have no exemption regarding the taxable income amount. Nevertheless, practice hasn’t recognized it so far. Even one of the most important theories, Hall-Rabushkin’s, predicts exemptions in this part while not even she recognizes any other mode of exemptions or money refunds.

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A certain number of researchers conclude that efficiency and success of a flat system essentially depends on the tax rate level that precedes the introduction of the same. The lower they are the greater chances the new system has to succeed and give results55. One of the most well-known proposals considering the introduction of a flat system was flat reform that was conducted by Hall and Rabushka56. The two of them suggested in 1985 that an overall flat system be used in the USA. Of course, with that they have opened the space for others to start pledging the same idea. In their 1995 analysis, the two of them suggest changing the five individual tax rates in the USA (15%, 28%, 31%, 36%, and 39.6%) and changing the different business tax rates all to one, flat 19% tax rate on a federal level. They excluded tiered marginal tax rates from their proposal, such as federal sales tax or VAT. These taxes were exempted because of the excluding impossibility of individuals and families with low incomes from among the taxpayers category. On the other hand, they were mainly occupied by the problems of the business sector and they proposed remarkable solutions in that area. Investment income (interest, dividends, and capital gains) was distinguished from salaries, wages and pension payments and wasn’t treated as personal income because it was already taxed once at the corporate level. Maybe the taxation level isn’t that important in this proposal because all income forms are taxed at the same rate. Nevertheless, their great contribution is the elimination of double taxation. Hall and Rabushka evaluated corporate tax obligations just after the exemptions of input, salaries, wages, pension and investments in factory and equipment expenditures. In their proposal, personal income tax was calculated in the following manner57:

Personal income tax = flat rate * [salaries, wages, pensions, smaller personal amends] On the other side, corporate income tax was calculated in the following manner:

Corporate income tax = flat rate * [total revenue from products and services sale

less other companies input purchase less salaries, pensions payed to employees less investments in factory and equipment] Evaluation of certain instruments benefits is possible only on a practical level. General allegations and reviews are not adequate. It is very important to learn by studying successfully implemented fiscal competition strategies and based on them, create your own. Of course, it is necessary to attempt that strategy and hope that it becomes even better than the competitor’s. As a good example of flat rate implementation, we can discuss Hong Kong. In this example, Ricardo’s comparative advantage theory fails. Hong Kong doesn’t have any natural resources but relevant institutions have given it and still give it recognition regarding its economic success, competitiveness, wealth, and life quality. Hong Kong is advancing further on the list, from eighth place in the world’s economic exchange. It has been proclaimed several times as economically the freest country in the world by the Fraser Institute. The same acknowledgement was also received from the Heritage foundation, which also measures the index of economic freedom. Simple low tax rate systems with simple and minimal administration are among the major reasons that Hong Kong has had this long and prosperous journey. It is interesting that even public expenditures in Hong Kong were increasing according to economic growth, it remain among the lowest in the world. That is quite a good example of the real public expenditure structure and the role of the state in the society. The tax system in Hong Kong has been defined to be as neutral as possible and without influences that may jeopardize the market mechanism. On the other hand, it fills out a second 55 www.euractiv.com 56 Robert E. Hall i Alvin Rabushka, Hoover Institution. Izvor: Critical Issues Bulletin: Flat Tax – Principles and Issues, Fraser Institute, 2001. 57 Andrei Grecu, Flat Tax – The British Case, Adam Smith Institute, London, 2004.


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important task regarding the state’s income sufficiency for their needs and programs. The dominant philosophy in Hong Kong is not just to expand the tax basis as much as possible but to make recollection and tax administration costs as low as possible. Today, Hong Kong has a dual tax system regarding income taxation. One option is a progressive tax from 2% to 20% with relief’s and abatement, while the other system represents a flat 16% system for overall income. Taxpayers in Hong Kong can choose between the two options, and majority choose a flat system. It offers a lower rate, zero preparation expenditures, as well as a significant reduction in the possibility of interrogation by tax authorities. Hong Kong doesn’t have VAT, doesn’t tax dividends, capital gains, wealth, or gifts, and it has a simple, efficient and inexpensive tax system. On the other hand, this tax system has generated significant incomes for the state. During 1950-1981, Hong Kong has recorded a budget surplus for 27 fiscal years, while public expenditures have grown. Is this a sufficient argument? The Hong Kong example is one example that fiscal policy can be a good mechanism for abatement of an economy’s competitiveness. Other interesting examples include the Channel Islands, Jersey, and Guernsey, which has a special status under Great Britain. It is not their status, the 20% flat rate, their tax exemption of capital gains, interest rate gains, retained profits, and capital transfers, or the inexistence of VAT that interest us because these things exist in other economies as well. The most interesting fact is that they have a special status into the EU, whose member they aren’t. Although they owe it to the UK and EU contract, it might be an interesting idea to consider Montenegro and EU relations, considering both the current situation as well as the development of future events. From among the socialist countries, Estonia was the first to begin with fiscal reform and she has proven that even with that background countries can have fantastic results. Rejecting the IMF proposals, Estonia has introduced a 26% flat rate system and eliminated reinvested profit taxation in 1994. Results of these measures were the improvement of economic performance, increased wealth and quality of life. Compressible with competitor’s moves, Estonia is planning to reduce that tax to 20% by 2007. INSTEAD OF CONCLUSION

Why can’t something like this be expected from Montenegro? Montenegro knows what needs to be changed. New thoughts and energy development with networking potential has brought and will continue to bring even more significant changes and will accelerate economic development and the creation of a wealthy society. Fiscal sphere traits, along with other numerous reform steps and success stories, must be continued. The lowest CIT rate in Europe, from 9%, must be precisely better and adequately implemented. The introduction of a flat system, especially in the area of income taxes that are still significantly high, is a reform trait that cannot wait for real time. Understanding the significance of fiscal system reform is much attended in Europe; therefore, we must change certain things even faster so as not to lose valuable investments. Only in this way can Montenegro become a regional business carrier and a place that will attract a significant number of investments. And, only then can we expect that the quality of life for our individuals will increase. Of course, changing the status quo and people’s way of thinking will not be easy, but it must be done if we are to create a competitive fiscal strategy. Changing the institutional and mental framework and its potential can contribute to positioning Montenegro as a competitive destination in the European market. Making this change and putting this kind of policy into practice may be more significant than what any other country has accomplished so far.

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LITERATURE 1. Bruce Bartlett, NCPA Senior Fellow, “Benefits of the Flat Tax,” National Centre for Policy Analysis 2. Katinka Barysch, “Is Tax Competition Bad,” CER Bulletin, Issue 37, August-September 2004 3. “Taxation in Globalizsed Economy,” Liberal Agenda 2000 Seminar, Prague, September 2005 4. “Critical Issues Bulletin: Flat Tax – Principles and Issues,” Fraser Institute, 2001 5. Jean-Philipe Delsol, “The Advantages of Tax Competition in Europe - The argument for Tax Equity

and Efficiency” 6. Stephane Garelli, “Taxes and Competitiveness – Is there any link?” – World Competitiveness

Yearbook 2005, International Institute for Management Development (IMD), May 2005. 7. Andrei Grecu, “Flat Tax – The British Case,” Adam Smith Institute, London, 2004. 8. “Funky business,” Jonas Riderstralle, Kjell Nordstrom, Plato, Belgrade, 2004 9. Veselin Vukotic, “Economic culture and competitiveness,” Entrepreneurial Economy Vol. X, December

2005. 10. Veselin Vukotic, “Conceptual basis of new economic system in Montenegro,” ISSP,2005 11. Veselin Vukotic, “Macroeconomic accounts and models,” CID, Podgorica, 2001 12. Ayn Rand, “Capitalism – unknown ideal,” Global Book, Novi Sad, 1994 13. www.euractiv.com

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THE IMPACT OF TAXES ON INVESTMENT ACTIVITY IN MONTENEGRO58 Author: Gordana Radojević, CARA

INTRODUCTION

Investments have an impact on the economy in two ways: one is related to investments on the supply side (technological advancement, knowledge, industrial capacities); and on the other side, the impact is felt through consumption (because investment consumption is part of the aggregate demand that, via multiplication, has an effect on the changes of the domestic product).

There is a high degree of correlation between GDP and investment activity in Montenegro. To increase GDP, we must increase investments and discover what affects and hinders investment activity in Montenegro. Who are the investors and what affects their activity? The first thought always goes to foreign investors, and while we cannot underestimate their importance, we often forget or diminish the importance of the domestic investors. Without the domestic investor and the savings of the population (which is a substantial source of investment), development of the economy is not possible.

I FACTORS THAT DIRECTLY AFFECT INVESTMENT ACTIVITY IN MONTENEGRO

Investment, as monitored by the official statistic in Montenegro, comprises the state and private sector. Data on investments of the state-owned sector is gathered on the basis of annual reports of investments in fixed assets, while investments in the private sector are estimations of the Statistics office of Montenegro (MONSTAT), on the basis of available statistical data and other sources.

Investments in the economy of Montenegro in 2005 are approximately EUR 372.4 million59, which represents a growth of 27.4% relative to the past year.

Graph 1 The investment60 changes from 2000-2005

Source: Monstat, estimations of ISSP (year 2005) 58.Comment is based on the quarterly Montenegrin Econometric Model (MMCG) completed by the ISSP for the purpose of the Central Bank of Montenegro. The MMMCG is conducted according to 20 sets of quarterly data starting with the first quarter of 2000 and going up to the fourth quarter of 2004. It includes 18 behavioral equations, which cover 10 industries and 5 identities. 59 Estimate – ISSP (the last available data on investments in the MONSTAT are for year 2004) 60.National Statistical Bureau is producing data regarding annual level of investments structured by industries, divided by the public and private sector. Total amount of investments in the private sector is calculated based on research in the construction industry, transportation and trade.

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In the structure of investments, there is great share of state owned, cooperative, and the mixed sector. Fluctuations in the level of total investments are caused by changes in these sectors. Investments in the private sector, after significant growth in 2001, have had stable growth in the following years. According to the Macroeconomic model, investment activity in Montenegro is directly determined by the following factors: active interest rate, industrial production, and state expenditures.

DLOG(INV) = -0.05–0.61*DLOG(AKS(-1)) + 1.12*DLOG(INDO) + 0.48*DLOG(KID)

INV – Investments AKS – Active interest rate of banks, average, it includes the rate for the population and for companies. INDP – is the index of the industrial production, with the base in year 1998 KID – capital expenditures of the state sector, intended for investment maintenance of the infrastructure and the supply of fixed assets. As the equation shows, there is a negative effect of the active interest rate on investments in Montenegro, as can be seen from the relation ∆INV = -0.61*∆AKS(-1), which is in concordance with the economic theory that due to the growth of investments there is fall of the active interest rate. The higher the interest rates are the higher the opportunity costs of investments are, thereby reducing investments; this relationship works conversely as well. Thus, with declining interest rates, the population and companies will increase the credits they take from banks in Montenegro and more of them will be taking credits, thereby increasing investments. The coefficient (-0.61) represents the elasticity of the growth rate of investments related to the growth rate of the active interest rate. Judging by the equation as a result of the real picture of the Montenegrin economy, an augmentation of one percent of industrial production results in growth of investments by 1.12 percentage points (∆INV = 1.12*∆INDP). The index of industrial production represents the changes in this area and it is expected that its growth will affect the growth of investments, and through them it will also affect the economy’s total growth. The high elasticity rate among investments and industrial production leads to the conclusion that the best stimulus for investments in Montenegro is the growth of industrial production. The weakest stimulus for investments in Montenegro is capital expenditures of the state, that is (∆INV=0.48*∆KID). Augmentation of these expenses of one percentage point leads to augmentation of investments of 0.48 percentage points. This variable is exogenous, outside the model, and its movement is affected only by government policies. II FACTORS THAT INDIRECTLY AFFECT INVESTMENT ACTIVITY With the macroeconomic model of Montenegro, the direct factors that affect investments are quantified. However, if investments and the factors that affect them are observed in the context of the whole issue, it is impossible to avoid analysis of the fiscal policy. How can an analytical connection be established between investments and fiscal policy? The most relevant mechanism of this connection is the influence of fiscal policy on industrial production (which has the largest influence on investments) and savings (as a source for investments). 2.1 Accelerator as a measure of influence of foreign ambient on investments It has been empirically proven that in Montenegro there is a high degree of elasticity between investments and industrial production (1.1), which leads to the conclusion that the best stimulus to investments is the growth of industrial production. This relation is supported by the accelerator. The reason for this is that the accelerator is related to the need of a company for


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capital, which is mainly affected by their level of production; capital augmentation (fixed funds) is only possible when production grows. In the roughest accelerator, there is a measure between the level of investments and the national income; it is an outcome of production. How can production be augmented if capacities are fully utilized? Income augmentation is only possible if capacities are expanded, that is, if the mass of fixed funds is enlarged. Enlarging the mass of fixed funds (e.g. enlarging production space) is possible only through new investments. Thus, when production is augmented, fixed funds must be augmented, and new investments will rise. However, once the level of fixed funds is adjusted to the new needs of production, fixed funds will not change and the impulse towards further investments will no longer exist. Accelerator is the measure of influence of the outer ambient on investments61. According to the MMCG, the total income of the state affects the growth of industrial production in the following way:

UKPRIMINDP ∆⋅−=∆ 29,0

A one percentage point augmentation of total state income (by increasing the tax rate) leads to diminished investments, by 0.29 percentage points. As industrial production directly affects the level of investments in Montenegro, the conclusion is that through the rise of taxes and the diminishing industrial production, there is a decline in investments. Thus, in that situation, companies have less income to reinvest. In order to create new value, the private sector needs to have enough resources for development, after the government collects its share (tax collection). On one hand, the rise of total state income is augmenting investments (through capital state expenditures), and on the other hand, it lowers them (through industrial production). There is a portion of state expenditures meant for investments, which has a positive influence on investments. Given the fact that investments are much more influenced by the rise of industrial production than by the rise of state expenditures, we can conclude that it would be much better if total state income was lowered (and industrial production raised) and that the newly available funds be redirected so that a larger part goes to capital expenditures (infrastructure building). 2.2 Savings as a source for investments Savings of the population is an important source for investments and it represents the remaining income of the population after they pay taxes and consumption. Personal consumption (S) is:

S=Y-T-C+Tr..

S –Savings C – Personal consumption T – Taxes Tr – Transfers

We can conclude that any augmentation of taxes by the state has a negative impact on the height of the income of the population, and on the savings. Consumer savings preferences go down with higher tax rates, and with it the sources for financing diminish. The level of savings in Montenegro is still low. The changes in savings from 2000 - 2005 is shown on the graph.

61 Source: Macroeconomic models and accounts, prof. Veselin Vukotic

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Graph 2 Saving of households in Montenegro (mil €)

In a closed economy, investments can only be as high as domestic savings, while in open economies, a large amount of foreign savings is present in investments. The basic characteristic of foreign savings is that they are high volatile, in moments of crisis and instabilities these savings are strongly shrunk, and because of that, foreign savings cannot be considered as a marker for the development of a country like domestic savings can. If households were able to increase their savings rate, to a level that is common for the surrounding countries, investments would also rise and the GDP growth rate and the population would have in time a greater standard. CONCLUSION Growth of GDP is not possible without the growth of investments, and the growth of investments is not possible without the growth of GDP. It is hard to define which one is the cause and which is the outcome. It is possible that high investments are the reason for high growth of GDP, but it is also possible to consider this the other way around. The correlation between investment activity and GDP growth in Montenegro is 0.85, which shows that the factors that affect investments either directly or indirectly will also affect the growth of GDP. The change of one element inevitably leads to the rise or fall of the other element. From the analysis it is clear that: o High taxes diminish investment activity – the rise of tax rates lead to the fall of industrial

production; the producers don’t have the interest to develop the business, to employ new workers, or to expand capacities;

o High taxes diminish the income of the population and their preferences towards savings. Savings are the most important source of investments!

SOURCES: 1. Veselin Vukotic: Macroeconomic models and accounts, 2004 2. Institute for Strategic Studies and Prognoses: Macroeconomic model of Montenegro, 2005 3. Mankiw Gregory: Macroeconomics,1997 4. Institute for Strategic Studies and Prognoses: Household Survey #7, 2003 5. MONSTAT: Annual Report, 2005

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TAX POLICY ON CAPITAL MARKET Author: Jelena Janjušević, ISSP

INTRODUCTION Capital and saving present very sensitive and mobile production factors. As higher taxes are on certain products there is less these products on the market. In that context, taxes represent a price that is applied on some activities; when that price is too high, the activities are discouraged or forbiden.

There have been and still are many economic debates about the necessity of creating a favorable investment environment that would provide low tax rates. In 1932 Franklin Roosevelt used to stress the negative impact of high taxes on economic prosperity: “Taxes are paid by every employee. Taxes that are too high will result in the closing of factories, the selling of agricultural properties in order to pay taxes, as well as to the appearance of hordes of hungry people that walk the streets desperately looking for a job62.” One of the founders of modern economic thought, William Petty, pointed out that the tax expense on the production and selling of goods is ultimately transferred from the producers to the consumers through higher prices. Modern research has confirmed Petty’s premises. When high tax rates deduct a great part of income, the motivation to work is lower, as well as the motivation to productively use the sources. High tax rates decrease the level of income and efficiency of capital accumulation. High tax rates discourage foreign investors, and domestic investors are obliged to find projects abroad to invest in because of lower tax rates. Therefore, the accumulation of capital, which presents an engine of economic growth, is lower. Domestic investors would rather choose projects that protect their present income from taxation than projects with a higher return rate if those projects have less likelihood of avoiding taxes. The business undertakings that would reflect losses will be extensive in order to protect income from tax. As a result of avoiding taxes, people choose projects that bring them profit, but they decrease the value of their resources. Capital is being spilled and the resources are canalized out of their most productive usage. There is tax competition between countries. Tax competition exists when people are able to decrease tax burdens by moving capital and/or labor from countries with high tax regimes to countries with low tax regimes. This type of migration disciplines “spendthrift” countries and repays countries that decrease tax rates and make reforms in order to stimulate economic growth. “As do other types of competition, fiscal rivalry creates positive results. Many people can keep more of the money that they have earned, and economic performance is improved with lower tax rates on labor, savings, and investments. Capital mobility that defines tax competition is also protected from misuse by authorities. Countries with a high tax regime promote various plans of tax harmonization in order to obstruct the outflow of work places and

62 Franklin Roosevelt, in Pittsburgh, October 19th 1932.

“Insight into the private circumstances of every human and insight to supervise the movement of his capital in order to apply tax on it would cause a permanent disturbance that no one can persist. The capital owner is undoubtedly a citizen of the world and cannot be permanently inherent to one country. If this were done to him, he would aspire to leave the country where permanent supervision is present and he would remove his capital to some other country or decide to enjoy his capital quietly. By removing his capital, he would stop all activity that he used to do in the country that he decided to leave. Capital cultivates land and capital employs labor. The tax rate that would result in the escapade of capital from the country would therefore drain every source of revenue to authorities, as well as to the nation. Not only do profits come from capital, but also from the land that is rented; additionally, with the removal of capital, workers’ wages would need to be decreased as well.” (Adam Smith, The Wealth of Nations, 1776.)

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capital from jurisdictions with high tax regimes to those with low tax regimes. Tax competition should be glorified not pursued63.” Today, that competition is composed of implementation of flat tax rates, instead of progressive, in order to stimulate rather than punish those that achieve better results, i.e. make high profits. Fiscal rivalry between authorities has created very favorable effects in the last 25 years. For example: o Countries around the world felt obliged to decrease the income tax rate after Thatcher and

Reagan have done that. o Tax competition helped to decrease corporate tax rates in welfare countries in West Europe. o Many nations among the ex-Soviet block abolished progressive tax rates, a process that was

hardly supported by tax competition. Tax burdens are present in all aspects of the economy; they present high ballast and put a stop to development. This becomes more significant on the capital market and is especially true in a small country like Montenegro that has a lack of capital, i.e. does not have many domestic investors. What can be done to attract foreign investors? The question is, why tax capital and savings? TAX POLICY ON THE MONTENEGRIN CAPITAL MARKET Corporate tax Law and the Income tax Law regulate taxation of capital income, i.e. dividend that enterprises (physical entities) earn by buying and selling securities on the capital market. Corporate tax Law The Corporate Tax Law in Montenegro was passed in January of 2002 and it predicted progressive taxation with tax rates of 15% and 20%. In December of 2004 the modifications and additions to this Law were adopted. According to those modifications, the tax rate was changed to proportional and its value is 9%. Adopting a proportional tax rate is an improvement in the sense that we are creating a favorable investment environment and providing equal treatment of investors who earn more. With progressive taxation, those who make higher profits have to pay a higher tax rate. In other words, those who work harder and who are more successful are ultimately punished because of their good outcome. Implementation of a proportional tax rate can only be an impulse for reinvesting and investing in long-term securities. The positive side of the modified Law is that in order to stimulate reinvesting, an additional change was made. Namely, profit made through the sale of securities that is reinvested within a 12-month period in the purchase of new securities is not included in the tax basis for the year in which the profit made. Additionally, profit made through the sale of securities that had been held in the taxpayer’s portfolio for over two years is not rated. “An investor who has invested in securities and held them for at least two years to later sell them at a higher price thereby making a profit was a 'good' investor who contributed to the company’s success by investing in the company as well as by voting for business decisions that resulted in the increased value of the company’s securities. A successful company realizes the expended sale, behaves under the market conditions, and pays VAT as well as other compensations, and the investor that realized a profit is excused from paying tax on that profit. Therefore, long-term investing is stimulated as well as investing in long-term financial instruments64.” However, behind the obvious improvements of Corporate Law, the tax rate could be decreased even more. Learning from the experiences of transition countries that have shown significant 63 Daniel Michel, Economy of tax competition – harmonization or liberalization 64 Z. Djikanovic, Tax stimulations to capital market development, Economic forum at Milocer, 2003


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success, as well as the development of their overall economy, by decreasing their tax burden to businesses proves the necessity of giving space to businesses as well as of stimulating investment and the inflow of foreign capital, which is necessary for every developing country. Moreover, because corporate tax represents a minor part of the budget (about 2%), abolition of this tax would not have a high negative effect on budget incomes, but it would have a positive and significant impact on market development. The lack of corporate tax Law is also evidenced by the existence of different tax rates after deduction; long-term investing is in an unequal position as compared to short-term investing. Namely, the tax rate on dividends is much higher (three times) than the tax rate on interest rates. Because of that, an investor who invested in the stock of some company must pay three times more to the state when he receives a dividend than a saver must pay when he receives his income rate on money that has been deposited in the bank. With this treatment of long-term investing, investors that already invested (as 240,000 Montenegrin citizens that have invested in Investment Funds) or investors that are planning to invest in shares of Montenegrin companies, are discouraged from investing and stimulated to deposit money in the banks, because the investment profit is not equally taxed. The capital market in Montenegro is a young market whose development is very important for the overall development of Montenegro. The Montenegrin capital market has realized significant results in a very short period of time, reaching the level of its neighbor countries. Capital market turnover represents 15% of GDP and is a very important sector of the Montenegrin economy. Therefore, state activities need to create a favorable environment for investing and stimulate long-term investments. An additional problem is the implementation of this Law, i.e. advanced payment of corporate tax. Tax calculation is based on profit realized in the previous period. This is not a good practice. Advanced payments of corporate tax should be based on real profits, not on the profits realized in the previous period. A company that has problems in their operation after having successfully ended the previous business year will face the extra burden of paying for its previous success thereby decreasing its possibilities to overrun their current operating crisis. An additional problem is that of tax calculation that is based on a profit estimation for new companies, which may not realize that profit during their first year of operation. Because of the mentioned problems, the tax burden should be based on real profit taken from the financial statements of a company, or an estimation of the tax burden should be based on operations in the first half of the year. Income tax Law The Income tax Law treats operations with securities through identification of: tax on personal income, income from capital, and capital gains and losses. Nevertheless, personal income includes other incomes, such as that realized in stocks and the amount of that income represents the nominal stock value. A tax rate of 15% has to be paid if that income is over 200€ monthly. The lack of this Law stresses the fact that the nominal stock value is used as the tax basis. The main characteristic of the Montenegrin capital market is that its stocks are underestimated, which means that the stock value at the market is much lower than its nominal value. These two values are equal only for stocks from a few companies. The difference between those two values is significant for a majority of stocks; the nominal value is higher. Therefore, if the nominal value is used as a tax basis (which is the case according to present Law) citizens are obliged to pay more. Or more precisely, a higher value of ownership is taken as a tax basis and this value is higher then the real ownership. It is not only a matter of the nominal value being much higher than the market value, but it is also a question of whether or not the market value will overtake the nominal value, and if so, when.

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Additionally, because the majority of Montenegrin citizens that own stocks received them through the MVP process, their income from stocks must be excused from paying taxes, at least until ownership concentration is made. Income realized through the sale of securities is also included under capital yield, and on this income tax should be paid under “general” tax rates: if the value of the rated income is up to 785 € the tax rate is 0%; if the income is from 785 to 2,615 € the tax rate is from 0 € + 15% for income over 785 €; if the income is from 2,615 to 4,577 € the tax rate is from 274 € + 19% for income over 2,615 €, and if the income is over 4,577 € the tax rate is from 647 € + 23 % for income over 4,577 €. Capital yield tax should be treated according to the following principles:65 o Reinvestment period is 12 months, o The prices of buying and selling stocks include fees, compensations, as well as taxes paid

while buying or selling stocks, o If the capital yield is realized two years after the initial purchase of stock (as a present, or

inherited), it is excluded of paying tax. EXAMPLES OF SUCCESSFUL TAX REFORMS Experience has shown a positive side of initiatives and efforts taken by countries in order to decrease the tax burden to businesses.

Thatcher - Reagan decrease of tax rates. Margaret Thatcher became Prime minister of the United Kingdom in 1979 and Ronald Reagan became President of the United States in 1981. Both leaders inherited weak economies, but they succeeded to recover growth and vitality by free market reforms. A drastic decrease of income tax was a crucial part of Thatcher’s, as well as Reagan’s, plan. The highest rate was 83% when Thatcher became Prime minister and she succeeded in decreasing it to 40%. In the United States, the highest rate was 70% when President Reagan was inaugurated and he succeeded in decreasing it to 28%.

Irish miracle and decrease of Corporate tax in Europe. By decreasing the income

tax, tax competition stimulated a decrease of corporate tax rates. Reagan’s decrease of tax rates was again meritorious for the beginning of that process, and corporate taxes have decreased dramatically since 1986.

But, the Irish miracle represents maybe the most impressive proof that tax competition contributes to a good tax policy. After less than 20 years, Ireland was economically a “hopeless case” with a binominal unemployment rate and an anemic economy. Weak performances were generated, at least partly, by a hard tax burden. The highest income tax rate was registered in 1984 and it was 65%; capital yield tax also reached its maximum of 60%, while corporate tax was 50%. Those rates were slightly decreased during the 1980’s, but the highest rates in 1991 were still very high: 52% income tax, 50% capital yield, and 43% corporate tax. At that moment, Irish leaders decided that “mending” the tax Laws is not a recipe for success. During the next 10 years, tax rates – especially capital yield and corporate taxes – were dramatically decreased. Today, capital yield tax is only 20%, and corporate tax is 12.5%.

65 Z. Djikanovic, Tax stimulations to capital market development, Economic forum at Milocer, 2003


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This aggressive “supply-siders” decrease of tax rates generated huge benefits. The Irish economy experienced the highest growth among all industrial nations. Its annual growth rate was 7.7% during the 1990’s. The late nineties were also very impressive with Ireland registering annual growth rates over 9%. In a very short period of time, the “European patient” became the “tiger of Kelths.” Unemployment decreased dramatically and investments have bloomed.66

The Irish people are the big winners. Once a relatively poor nation, now Ireland has the second highest life standard within the European Union. Even the state experienced benefits. During the mid-nineties when the corporate tax was close to 50%, it represented income that was barely over 1% of GDP. Today, the corporate tax rate of 12.5% generates almost 4% of GDP.

Thanks to tax competition, the Irish decrease of tax rates had a positive effect on the rest of Europe. The Irish miracle motivated other countries within the EU to significantly decrease their tax rates during the last decade. Those lower rates will improve economic performance and they should encourage the creators of European Economic Policy to decrease other taxes as well.

Tax reform in East Europe. One of the most incredible events in fiscal policy is the implementation of proportional tax rates, or the abolition of the progressive tax rate, in the Ex-Soviet block countries. Three Baltic countries – Estonia, Lithuania and Latvia – adopted proportional tax systems during the 1990’s and tax reform in the Baltic provoked a hard cycle of tax competition. Russia also implemented a proportional tax rate of 13% in 2001. The Ukraine recently approved a proportional tax rate of 13% and Slovakia has a proportional tax rate of 19%. Those proportional tax regimes are not enough to resolve all of the problems that exist in post communist countries, but there is already proof that adequate tax policy does have a favorable result. For example, the Baltic countries have the most prosperity among all countries that have been created from the Ex-Soviet block. Russian Federation was the next to implement a proportional tax rate, so it will be no surprise if Russia is the next ex-Soviet “republic” with the most prosperity.

The example of Russia, where a 13% proportional tax rate generated dramatic results, is especially impressive. The Russian economy has been generating 10% growth since 2001, which may not sound like much, but it is very important if we take into consideration the backlash of the global economy. In any case, the Russian economy had better results than America and was far ahead as compared to growth rates in the rest of Europe.

Through faster growth, Russian tax reform had a dramatic impact on its peoples’ willingness to pay taxes. During the last few years, revenue from income tax increased by about 60% once inflation is subtracted; clearly, people are willing to produce more and pay their taxes when the system is fair and tax rates are low.

INSTEAD CONCLUSION Tax competition has played a role in every one of those success stories. In some countries, benefits arrived because politicians wanted to copy other successful countries, while in others, authorities managed good tax policies because they were afraid that work places and capital would leave their territory. Regardless of their motives, a good tax policy in one jurisdiction has a positive impact on other jurisdictions.

66 Source: Daniel Mitchell, Economy of tax competition –harmonization or liberalization

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LITERATURE 1. Daniel Mitchell, Economy of tax competition – harmonization or liberalization 2. James Gurnee, Richard Strop, Economy and prosperity, what anyone has to know about

market economy, Belgrade, 1996 3. Friedman M., Capitalism and Freedom, Global book, Novi Sad, 1997 4. Friedman M., Choice and Freedom, Global book, Novi Sad, 1997 5. Henry Haslett, Economics in one lesson, Global book, Novi Sad, 1998 6. Zoran Djikanovic, Tax stimulations to capital market development, Economic forum at Milocer,

2003 7. Vukotić V., Privatization, Institute of Social Sciences, Belgrade, 1993 8. Corporate tax Law, Službeni list RCG", No 65/01 i 12/02 9. Modifications and amendments of Corporate Law, "Službeni list RCG", No 65/01 10. Income tax Law, Službeni list RCG", No 65/01 i 12/02 11. Modifications and amendments of Income tax Law, Sl. List RCG, No 65/01, 12/02, 37/04 ,29/05 12. www.worldwide-tax.com 13. www.skupstina.cg.yu

http://www.worldwide-tax.com/

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TAX WEDGE ON THE WAGE LABOR COST - COMPARISON OF MONTENEGRO WITH SEE COUNTRIES Author: Ana Krsmanovic, ISSP

There are two main types of barriers on the labor market, both of which have negative employment effects, as experienced in the international practice. The first type of barrier relates to wage formation and wage taxation, while the second type of barrier relates to the signing and ending of the labor contract. Both types of barrier represent the government’s intervention on the labor market, with the main goal of protecting workers. Social security contributions are imposed with the main goal of insuring employees against risks (old age, unemployment, sickness), while personal income tax could be viewed as a fee for services that the government provides to individuals. The barriers/regulations that are primarily related to ending labor contracts should secure employment for those employed. In this paper, the barriers related to wage taxation in Montenegro and seven new EU member countries are discussed. WHAT IS TAX WEDGE? Tax wedge is an indicator that depicts what share of the wage labor cost is transferred to the government in the form of social security contributions and personal income taxes. The tax wedge has three main components – employees’ share of social security contributions, employers’ share of social security contributions, and personal income tax. The economic literature suggests that the influence of the tax wedge on employment depends on the elasticity of the labor supply (demand) curve. The more elastic the labor supply curve is the more harmful is the tax wedge to the labor market. If the labor supply curve (labor demand curve) is vertical as shown in graph 1, meaning that the supply is the same at any wage level, an increase of the tax wedge would lead to a decrease in net wages (or an increase in total labor cost); in other words, employees (or employers) accept to take over the financial burden. In this case, there would be no decrease in employment. On the other hand, if the labor supply curve is horizontal (graph 2), meaning that regardless of the wage level, the labor supply increases, workers are unable to accept any net wage decrease. Thus, an increase in the tax wedge is fully transferred to employers and they reduce employment, unless the respective demand curve is vertical and they accept the rise of labor cost without reducing employment.

Graph 2: Horizontal labor supply curve and tax wedge D

Wage D'

S S

D D'

A B Employment

Graph 1: Vertical labor supply curve and tax wedge D S

Wage D'

A

B

D D'

S Employment

DD-labor demand, SS-labor supply, D’D’-labordemand after tax wedge

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According to empirical findings, mainly from OECD67 research, the tax wedge has a larger influence on employment in labor market segments where wages are relatively lower. In other words, since the wage differentials among individuals are mainly explained by level of skill, the negative employment effects of the tax wedge (tax burden) could be to a greater extent reflected on the lower-skilled workers (see graph 3). This finding is supported by the results of surveys done in Belgium, France, and the Netherlands, all of whom have managed to increase employment among this group of workers by introducing special payroll tax reductions for low-wage earners. Graph 3: The labor market and the tax wedge

According to Nickell,68 the increase in the tax wedge that occurred between the 1960’s and the 1990’s, in great measure explains the employment rate differences among the OECD countries of France, Germany, Italy, and the USA. The way in which the tax wedge influences employment in a country, according to him, also depends on the institutional framework of the country’s labor market (minimum wage regulations, unemployment benefits, share of tax burden that is levied on employers and employees, average skill level of the labor force, real wage rigidity, and the prevailing structure of wage bargaining).

The economic literature identifies several factors that determine the influence of the tax wedge on employment, i.e. tax-employment elasticity69: 1. skills of the labor force – the lower the skill level of the labor force makes a higher

probability that a higher tax wedge will have a negative impact on employment; 2. reservation wage (alternative income) – a higher reservation wage, which is influenced by

the minimum wage and other income opportunities, leads to a greater share of potential low wage earners being unemployed;

3. relationship between taxes and benefits and taxation of non-employment benefits – in the case that benefits are not taxed, the influence of personal income tax is high;

67 OECD -”Employment Outlook 2003” 68 Nickell – “Employment and taxes”, working paper 69 “Tax wedge and skills: Case of Poland in international perspective”, CASE (www.case.com.pl), 2006

Dh - demand for skilled labor Dh’ – demand for skilled labor after tax wedge Dl - demand for unskilled labor Dl’ - demand for unskilled labor after tax wedge AB – employment reduction among skilled workers due to tax wedge CD - employment reduction among unskilled workers due to tax wedge without minimum wage CE - employment reduction among unskilled workers due to tax wedge with minimum wage

M in im um w age

Em p loym ent E D C B A

D l' D l

D h'

D h

Wag

e


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4. effective tax burden paid by employers and employees – payroll taxes (paid by the employer) supposedly have a much stronger negative effect on employment;

5. wage formation and the relative strength of the party and degree of bargaining centralization – when trade unions are strong and wage bargaining is not centralized, the negative effect of tax wedge on employment is high; while if the bargaining is strongly centralized or strongly decentralized, effects are usually smaller;

6. tax progression – tax progression limits the negative employment effects of the high average income tax;

7. direction of change – the negative effects of a tax wedge increase on employment can be much stronger than the positive employment effects of a decrease, since wages tend to be more flexible upwards than downwards.

These factors that influence the elasticity of the labor supply also influence each other. For example, a binding minimum wage is limiting downwards wage flexibility. Also, one of the minimum wage consequences is that its existence acts as a disincentive for people to enroll in the educational system, thus maintaining a lower average level of skills. TAX WEDGE ON THE WAGE LABOR COST IN MONTENEGRO AND IN NEW EU COUNTRIES The tax wedge indicator can include only wage related labor costs as well as total labor cost. The difference between wage labor cost and total labor cost is that total labor cost also includes other benefits that employers provide or are obliged to provide to their employees (such as meal allowance, holiday allowance, housing allowance, etc.). The analysis of the tax wedge presented here relates only to wage labor cost (on the fiscal burden imposed on wages). Table 1: PIT rates70 in the selected SEE countries and in Montenegro

Country Income brackets (annual income in €) and corresponding tax rates

income bracket (€) 1200 3413 6825 10350 > 10350 Czech Republic tax rate (%) 0 15 20 25 32 income bracket (€) 1074 > 1074 Estonia tax rate (%) 0 24 income bracket (€) 2381 3177 5957 > 5957 Hungary tax rate (%) 0 18 26 38 income bracket (€) 360 > 360 Latvia tax rate (%) 0 25 income bracket (€) 994 > 994 Lithuania tax rate (%) 0 33 income bracket (€) 780 2616 4572 > 4572 Montenegro tax rate (%) 0 15 19 23 income bracket (€) 620 8228 16455 > 16455 Poland tax rate (%) 0 19 30 40 income bracket (€) 2019 > 2019 Slovakia tax rate (%) 0 19 income bracket (€) 1477 6669 13338 20007 26676 40014 > 40014 Slovenia tax rate (%) 0 17 35 37 40 45 50income bracket (€) 5208 13032 36456 Croatia tax rate (%) 15 25 35 45 income bracket (€) 1/4AAW71 2AAW 5AAW > 5AAW Macedonia tax rate (%) 0 23 27 35 income bracket (€) 1106 1536 3686 7201 Bulgaria tax rate (%) 0 20 22 24 income bracket (€) Serbia72 tax rate (%) 14

Sources: World Bank, EU-8, Quarterly Economic Report, www.worldwide-tax.com, Ministry of Finance of Montenegro

70 In the % of gross wage 71 AAS – average annual wage 72 In Serbia proportional taxation is in force.


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The first component of the tax wedge – personal income taxation, varies among the SEE countries. The tax system in Serbia, Estonia, Latvia, Lithuania and Slovakia is proportional and assumes the existence of tax-exempted income (except in Serbia), while tax rates vary from 14% in Serbia to 33% in Lithuania. In other countries (Poland, Slovenia, Hungary, Croatia, Macedonia, Bulgaria and the Czech Republic) the personal income tax system is progressive, with rates ranging from 15% to 50%, and includes tax-exempted income (except in Croatia). Personal income taxation in Montenegro is also progressive with rates ranging from 15% to 23%, while tax-exempted annual income is €780. The second component of the tax wedge – social security contributions (SSC) paid by employees, is highest in Poland (25% of gross wage) and lowest in Estonia (1% of gross wage); while in Macedonia, employees do not pay these contributions at all. The level of SSC paid by employees in Montenegro is the fourth highest among the selected group of countries (20%). Table 2: Social security contributions rate (in % of gross wage)

Employer Employee Total

Czech Republic 35.0 13.0 48.0

Estonia 34.0 1.0 35.0

Hungary 32.0 14.0 46.0

Latvia 24.0 9.0 33.0

Lithuania 31.0 3.0 34.0

Montenegro73 16.1 20.0 36.1

Poland 21.0 25.0 46.0

Slovakia 35.0 13.0 48.0

Slovenia74 16.0 22.0 38.0

Croatia 16.7 20.5 37.2

Macedonia 30.1 - 30.1

Bulgaria 29.5 12.5 42.0

Serbia 17.9 17.9 35.8

Sources: World Bank, EU-8, Quarterly Economic Report, www.worldwide-tax.com, Ministry of Finance of Montenegro Social security contributions paid by the employer are, on the other hand, lowest in Montenegro, Slovenia, and Croatia (16.1%, 16%, and 16.7% respectively), while these contributions are highest in the Czech Republic and Slovakia (35%). Total SSC (both employers and employees share as % of gross wage) are highest in the Czech Republic and Slovakia (48%) and lowest in Macedonia (30.1%). The total SSC rate in Montenegro is relatively low, amounting to 36.1% of gross wage

However, the effective rates of contributions and tax matter, and they will be the subject of further analysis.

In order to achieve a greater degree of comparability in our analysis of the tax wedge among the selected countries, the analysis focuses on the burden imposed on the average wage of a specific activity. For this purpose, the OECD and other international institutions use earnings of the average production worker in manufacturing (APW). The average gross wage in manufacturing activity is used in this analysis as a benchmark for determining the tax wedge on the wage labor cost. The total labor cost is obtained by adding the employers’ share of contributions to the gross wage (gross wage includes employees share of contributions and personal income tax). Data for all countries is from the fourth quarter of 2005 and was obtained from the respective statistical offices.

73 Aside from these social security contributions (pension, unemployment and health insurance), employers in Montenegro pay two additional contributions – 0.32% as contribution to Chamber of Commerce and 0.2% as contribution to workers union. 74 Slovenia has an additional payroll tax paid on a monthly gross wage over €668, with rates ranging from 3.8% to 14.8%.



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Table 3. Average wages in the manufacturing industry and tax wedge imposed on these wages (Q4-2005)75

Average gross wage

in manufacturing activity

Total tax and contributions

liability Net wage Total wage labor

cost Tax wedge (%)

In € monthly In %

Slovenia 1063.1 655.1 578.1 1233.2 53.1

Poland 534.7 337.7 309.3 647.0 52.2

Hungary 578.8 369.7 394.3 764.0 48.4

Lithuania 388.8 229.3 252.8 482.1 47.6

Czech Republic 621.8 398.8 440.7 839.4 47.5

Slovakia 510.9 310.3 379.4 689.7 45.0

Montenegro 302.7 149.9 203.1 353.1 42.5

Serbia 267.2 133.1 182.0 315.0 42.3

Macedonia 224.5 116.0 161.7 277.8 41.8

Croatia 777.2 440.0 617.8 1057.8 41.6

Estonia 508.3 278.4 402.7 681.1 40.9

Bulgaria 154.6 77.4 122.9 200.3 39.7

Sources: respective statistical offices and ISSP calculations

The average monthly gross wage in the fourth quarter of 2005 in the selected countries varies from €154.6 in Bulgaria to €1063.1 in Slovenia. On the other hand, the tax wedge on the wage of APW (average production worker in manufacturing) is lowest in Bulgaria (39.7%) and in Estonia (40.9%). The tax wedge on the wage of an average production worker in manufacturing in Montenegro is lower than the selected EU member countries (Slovenia, Slovakia, Poland, Lithuania, Hungary and the Czech Republic); however, as compared to other countries in the region, the tax wedge in Montenegro is slightly higher. For example, the tax wedge in Serbia, which has a relatively low flat tax rate with no tax-exempted income, is 42.3%; while in Montenegro, the tax wedge is 42.5%. Also, the corresponding tax wedges in Macedonia and Croatia are lower by 0.7 and 0.9 percentage points. The highest tax wedge on the wage of APW is in Slovenia (53.1%) and in Poland (52.2%).

Graph 4: Total tax wedge for 100% APW

14,8% 13,5% 9,4%20,9%

11,9%20,4%

14,2% 14,3% 11,7%6,4%

11,9%

0,7%10,6%

9,6%

7,3%

9,6%

19,0%20,7%

15,1%

0% 9,9%

15,2%

25,4%

14,3% 24,2%25,9%

19,4%25,9%

13,8%17,4%

12,3%

30,1% 23,4%

15,2%

11,1%

17,1%

0,0%

10,0%

20,0%

30,0%

40,0%

50,0%

60,0%

Esto

nia

Mon

tene

gro

Hun

gary

Slov

akia

Lith

uani

a

Czec

h Rep

ublic

Slov

enia

Pola

nd

Croa

tia

Mac

edon

ia

Bulg

aria

Serb

ia

Q4-2005 average

Tax

wed

ge f

or 1

00

% A

PW

PIT 100%APW SSC employee 100%APW SSC employer 100%APW


75 Wage data for Serbia, Macedonia and Bulgaria are averages for February 2006.

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In addition to the analysis of the tax wedge on the average wage in manufacturing, the wage itself is usually analyzed, which is 50% lower, under the assumption that this level of wage is close to the level of the minimum wage in all mentioned countries. In the case of 50% APW, the tax wedge is lowest in Bulgaria, Macedonia, Estonia, Croatia and Montenegro (32.4%, 37.4%, 37.7%, 38.7%, and 39.3%, respectively), while it is highest in Poland (50.7%). The difference between tax wedges for 50% APW and 100% APW could be explained by income taxation (the number and amount of tax brackets and tax rates) as well as by the level of social security contributions. For example, in Slovakia for 100% APW, the tax wedge is the third lowest, while for 50% APW, the tax wedge is the fourth lowest; this is determined by the rate of social security contributions, which is highest in Slovakia from among the selected countries. In Serbia, the tax wedge is the same regardless of the level of income, and it is relatively high.

Graph 5:Total tax wedge for 50%APW and 100%APW

37,7 39,3 39,7 40,4 41,944,0 44,0

50,7

38,7 37,432,4

42,343,3

48,445,0

47,6 47,5

53,1

41,6 41,839,6

42,340,9

52,2

0,0

10,0

20,0

30,0

40,0

50,0

60,0

Esto

nia

Mon

tene

gro

Hun

gary

Slov

akia

Lith

uani

a

Czec

h Re

publ

ic

Slov

enia

Pola

nd

Croa

tia

Mac

edon

ia

Bulg

aria

Serb

ia50 %APW 100%APW

The structure of the tax wedge by its components (social security contributions and personal income tax) shows that social security contributions account for the largest part of the total paid taxes and contributions. The highest share of contributions in the total tax wedge is in Bulgaria (83.9%) and Slovakia (79%), where social contribution rates are the highest from among the observed countries. The highest share of personal income tax is in Lithuania (44%) and Slovenia (38.3%). The lowest share of personal income tax in the total tax burden is in Bulgaria (16.1%). The share of PIT in Montenegro is relatively low, as compared to other countries in the group.


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Graph 6: Structure of tax wedge by components for 100%APW

36,1%25,2% 28,0% 21,0%

44,0%

25,2%38,3%

27,2%34,3% 27,9%

16,1%28,2%

1,8%39,1%

21,9%21,4%

15,3%

20,3%

35,7%

39,6%36,2%

0,0% 24,9%

35,9%

62,1%

35,7%50,1%

57,6%40,7%

54,6%

26,0%33,2% 29,5%

72,1%59,0%

35,9%

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

Esto

nia

Mon

tene

gro

Hun

gary

Slov

akia

Lith

uani

a

Czec

h Rep

ublic

Slov

enia

Pola

nd

Croa

tia

Mac

edon

ia

Bulg

aria

Serb

ia

PIT SSC employee SSC employer


In addition to the percentage of tax wedge, another important feature of this indicator is its composition – what share of tax and contributions do employers pay and what share do employees pay. Having in mind that the employer’s share of tax liability is very important with respect to the influence that the tax wedge has on employment, the least favorable structure of tax wedge is had in Macedonia, Estonia and Bulgaria. Therefore, regardless of the actual share of tax burden in the wage labor cost, these countries have the highest probability that an increased tax wedge will have a negative influence on employment. In the same way, despite the fact that they have the highest tax wedges among the observed countries, Slovenia, Croatia, and Poland have the most favorable structure in terms of employers’ share of contributions. However, the high level of tax wedge in these countries does have a negative influence on employment, as well as in other countries, because it makes labor more expensive.

Table 4: Structure of tax wedge

100% APW 50% APW

Employees share of tax and contribution liability

Employer share of tax and contribution liability

Employees share of tax and contribution liability

Employer share of tax and contribution liability

In %

Estonia 37.9 62.1 32.7 67.3 Montenegro 64.3 35.7 63.2 36.8

Hungary 49.9 50.1 38.9 61.1 Slovakia 42.4 57.6 35.8 64.2 Lithuania 59.3 40.7 53.8 46.2

Czech Republic 45.4 54.6 41.1 58.9 Slovenia 74 26 68.7 31.3 Poland 66.8 33.2 65.8 34.2 Croatia 70.5 29.5 68 32 Bulgaria 41 59 29.6 70.4

Macedonia 27.9 72.1 8.7 91.3 Serbia 64.1 35.9 64.1 35.9


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In Montenegro, the larger share of tax and contributions is the employee’s commitment, 64.3% of total liability for the average wage in manufacturing (100% APW) and 63.2% for 50% APW. The difference between these two categories is in the paid personal income tax, which increases with an increase in gross wage.

Tax progression is also one of the factors that influence the degree of influence that the tax wedge has on employment. Tax progression limits the negative influence of a high average tax rate. The tax wedge progression is highest in Slovenia and Hungary and it is lowest in Estonia and Slovakia. In Serbia there is no tax progression; this fact contributes to the negative influence of the tax wedge on employment. The progression of the tax wedge is determined by the progression of personal income tax, since social security contributions do not vary according to the level of income.

Graph 7:Tax progresivity in selected countries

30,0

35,0

40,0

45,0

50,0

55,0

60,0

50 %APW 67 %APW 80%APW 100%APW 125%APW 167%APWEstonia Montenegro HungarySlovakia Lithuania Czech RepublicSlovenia Poland

Other factors that determine to what degree the tax wedge will have a negative influence on employment are: level of skill among the labor force, degree of wage bargaining centralization, and the existence of a national minimum wage. The average level of skill among the labor force in the mentioned countries is below the EU average, thus making their employment situation more highly influenced by the tax wedge. In Montenegro, 6.7%76 of employed persons have a primary or less than primary education, and thus fall in the category of unqualified workers. On the other hand, 61.5% of employed persons have completed secondary education. With regards to a national minimum wage as an important factor in the tax-employment relationship, in all of the selected countries there are binding national minimum wages. The influence of national minimum wages is especially effectuated at the lower-skilled workers. The existence of a national minimum wage limits the downwards adjustment in wages when the tax wedge increases, thus leading to a downwards adjustment in employment. Also, if the downwards adjustment in employment is not easily achieved due to a high level of employment protection in a country, then employers will retain themselves from employment. Montenegro also has a national minimum wage; however, the situation in Montenegro is somewhat

76 ISSP household survey data, December 2005.


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complicated by the fact that there are ten different levels of minimum wage, depending on the level of education. Additionally, the degree of employment protection in Montenegro is high. The wage bargaining process in all of the mentioned countries is a mixture of a centralized and decentralized approach; so from the aspect of tax wedge and employment, it should have a positive impact. TRENDS IN THE TAX WEDGE IN THE OECD COUNTRIES The negative impact on employment that comes from the fiscal burden that is imposed on labor has become widely known and accepted, so the general trend present in the world is the decrease of the tax wedge. Observing the data for the OECD member countries (graph 9), it is obvious that in all OECD member countries, the tax wedge has decreased from 1998 to 2004.

Graph 9: Average tax wedge on labour at 67% of APW in OECD and Montenegro

KOR

MEX

JPNISL

NZL

AUS

IRL

CHE

CAN

GBR

LUXUSA

PRTNOR

ESP

GRC EU15NLD

FRA

SVK DNKCZE

AUT

POL

FIN

TURITA HUN

DEU SWE BEL

Montenegro

0

10

20

30

40

50

60

0 10 20 30 40 50 60

2004

1998

OECD average

OECD

Source: OECD Taxing Wages database and ISSP calculations The average tax wedge of APW in OECD in 1998 amounted to approximately 34.0% and it was reduced to 32.5% in 2004. The average tax wedge in Montenegro is also decreasing; however, the decrease in Montenegro is more dramatic than in OECD (from approximately 54% in 1998 to 40.4% in 2005). However, even with this dramatic decline, the tax wedge in Montenegro is still higher than the average OECD, by approximately 7.5 percentage points. CONCLUSION The tax wedge imposed on labor influences employment/unemployment. In comparison to the new EU member states, Montenegro has the second lowest tax wedge, while Estonia is the country with the lowest tax wedge. As concluded in the analysis, the structure of the tax wedge in Montenegro, in terms of employers’ share of social security contributions, is not so unfavorable in terms of the tax-employment relationship; however, the personal income tax makes a relatively smaller share of the total tax burden. On the other hand, the institutional framework of the labor market (high level of employment protection) leaves little room for adjustments, either in employment or in wage, so employers retain themselves from employment.

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The decrease of taxes and overall fiscal burden is a trend that is very much present in the world, especially among those countries that are in transition or are less developed; it is used as a tool for boosting economic activity and attracting foreign direct investments. In several countries in Europe, personal income tax has been reformed and a flat tax has been introduced (Slovakia, Estonia, Russia, Ukraine, Romania, etc), which has contributed to the decreased tax wedge. For now it seems that the only way to decrease the tax wedge is to reduce personal income tax, since a reduction in social security contributions is somewhat difficult due to the pension system crises. Montenegro has already reduced the personal income tax several times in the period from 1998 to 2005, and they have also reduced the employers’ share of contributions (by 20% in 2004 and 2005); both of these factors have led to a significant decrease in the tax wedge. However, the tax wedge in Montenegro is still above the average OECD level, which implies that Montenegro could further improve its competitive position relative to the OECD members by reducing the fiscal burden imposed on wage labor cost. The government of Montenegro is already planning to cut personal income tax; however, this reduction in PIT should also be followed by a relaxation of the rigid labor market regulations, thereby allowing the effects of PIT reduction to be more positive in terms of increasing the registered employment levels. This would have many positive consequences, besides an increase in registered employment, there would also be an increase in government revenues (although this is not a prime goal), an increase in pension fund revenues, as well as an increase in investments (both foreign and domestic) and overall economic activity. LITERATURE 1. Gora M., Radyiwitt A., Sowa A., Walewski M. – «Tax Wedge and Skills: Case of Poland in

International Perspective», CASE, Varšava, Poljska, 2006. 2. Social Security Administration USA – «Social Security Programs Throughout the World: Europe

2004», SSAUSA, 2005 3. World Bank –«Quarterly Economic Report –«Special Topic: Labor Taxes on Employment in the EU-

8», april 2005.Funck B. i L. Pizzati - Labor, Employment, and Social Policies in the EU Enlargement Process: Changing Perspectives and Policy Options”, Svjetska Banka, Washington, 2002.

4. European Commission-Employment and labor market in Central European countries, 2001/1 5. Heitger, B.- The Impact of Taxation on Unemployment in OECD Countries, Cato Journal Vol. 22,

No.2, 2002 6. Krsmanovic, A. - Uticaj radnog zakonodavstva na tržište rada u Crnoj Gori-Indeks zakonske zaštite

zaposlenja- Preduzetnička ekonomija, Volume 2, 2003 7. Nikell – “Employment and taxes”, OECD 2003 8. Crna Gora - http://www.monstat.cg.yu 9. Hrvatska - http://www.dzs.hr 10. Češka Republika - http://www.czso.cz 11. Mađarska - http://portal.ksh.hu 12. Litvanija - http://www.std.lt 13. Makedonija - http://www.stat.gov.mk 14. Poljska - http://www.stat.gov.pl 15. Srbija - http://www.statserb.sr.gov.yu 16. Slovačka - http://www.statistics.sk 17. Slovenija - http://www.stat.si 18. Estonija - http://www.stat.ee 19. Bugarska - http://www.nsi.bg

http://www.monstat.cg.yu/

http://www.dzs.hr/

http://www.czso.cz/

http://portal.ksh.hu/

http://www.std.lt/

http://www.stat.gov.mk/

http://www.stat.gov.pl/

http://www.statserb.sr.gov.yu/

http://www.statistics.sk/

http://www.stat.si/

http://www.stat.ee/

http://www.nsi.bg/


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COMPARATIVE OVERVIEW OF EXCISE DUTIES REGULATION IN THE EUROPEAN UNION AND MONTENEGRO Author: Ivana Vojinović, ISSP

1. INTRODUCTION Excises are a special indirect tax placed on the consumption or use of specific products. Most often they are levied on tobacco and tobacco products, derivatives of crude oil, alcoholic beverages, pure alcohol (ethanol), coffee, luxury products (products containing 2% or more of gold or other precious metals, or those containing more than 50% of silver), natural precious rocks and natural pearls, products made from the skin of reptiles, refreshing non-alcoholic beverages, salt for eating, etc. The main goal of excises is fiscal benefit. However, the obligation to pay excises also acts as a disincentive on the consumption of those particular products that may be harmful to our health, such as alcoholic beverages and tobacco; and excises also have an impact on the redistribution of income, by way of the excises on luxury products. Excises become due at the moment the product is put into operation or at the moment the product is imported77. Typically, the one that must pay the excise is the producer or the importer of the product. The excise duty is usually determined as a fixed amount for a certain type (group) of products, and is most frequently assigned per unit of measurement (volume, quantity, weight, etc.). However, the al valorem excise also exists – with this, the excise amount is determined by applying a proportional rate on the tax base of the retail price. 2. EXCISE DUTIES REGULATION IN THE EUROPEAN UNION All EU member states apply excise duties on the following product categories:

alcoholic beverages,

tobacco products, and

energy products (motor and heating fuel, such as different types of petrol, electricity, natural gas, coal and coke).

Excise revenues are revenues of the member states. EU legal regulation of this field, which was introduced in the context of the internal market on January 1st of 1993, defines the following: categories of products subject to excise duties, the way in which excises are calculated (e.g. hectoliter, degree of alcohol, 1000 pieces, etc.), possible exemptions, minimal excise rates that member states have to apply for each product type that is subject to excise duties, etc78. Although the Council of Ministers does not require full harmonization of excise rates as a precondition to the proper functioning of the common EU market, a series of minimal rates have been agreed on. Each member state has the sovereignty to set excises at a level above the defined minimal rates if they think that such rates best suit their national conditions.

77 The moment a product is put into operation is the moment when it is forwarded from the plant (forwarding in own warehouse to the other location, delivery into own outlet, delivery to the buyer). It is possible to establish a so called excise warehouse, and excise outlet for products that are made from precious metals and precious rocks; in this case, excises become due only after such warehouse and outlet are open to traffic. 78 The basic principles applied to all excise products are defined in the Counsel Directive 92/12/EEC from February 25th of 1992, which is based on the General Agreement on excise products and the way of keeping, moving and monitoring these products. After production, excise products might be subject to excise suspension and kept in excise warehouses. Establishment of excise warehouses and their operating activities is under the authorization of member states. Thus, they should obey the principles from the Commission Recommendation 2000/789/EC.

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A distinction has to be made between commercial traffic and transport of goods by private people. For commercial traffic, the principle of taxation in the member state of destination applies. To avoid double taxation, Directive 92/12/EEC provides for a system of reimbursement of the excise duty paid in the first member state, subject to conditions to be determined by that member state. For excise products purchased by private travelers for their own use and transported by themselves from one member state to another, the principle of taxation in the member state of origin applies. This means that the excise duty will be due only in the member state of purchase and that no further excise duty applies in any other member state to which products are transported. 2.1 Alcoholic beverages According to the EU Directive 92/83/EEC, the following categories of alcoholic beverages are subject to excise duty: beer, wine, other fermented beverages other than beer and wine, intermediate products and ethyl alcohol 79. The excise duty is fixed per hectoliter of pure alcohol at 20°C. The previously mentioned minimal rates (Directive 92/84/EEC) are shown in the following table:

79 Term "ethyl alcohol" is related to the alcohol used as a beverage, for industrial purposes, for production of food, medicines etc. The general approach is that excises are calculated only on the alcohol used as a beverage.

Box 1: Movement and control (EMCS) Because of the growing number of fraudulent transactions within member states, and, consequently, the loss of national revenues, especially in the tobacco and alcohol field, ECOFIN has proposed the establishment of a computerized trader-to-trader link via national administrations of member states under the name EMCS (Excise Movement and Control System). The goal of the system is to replace the current paper-based follow-up system of movement of excise products for which payment of excises has been suspended between authorized economic operators within the Community. This system will improve functioning of the common market via: o simplification of the movement of goods that

are under excise suspension through electronic transmission of necessary documents;

o provision of movement of goods by checking trader data before the goods are forwarded and by more quickly and safely returning records that the goods have found their destination;

o monitoring the movement of excise goods through the on-time information and checks during the process of movement of goods.

o Thus, the Commission has published a draft of the Specification of excises system (functional and technical), which has to be implemented by member states by June 30th of 2009 in each excise sector (alcohol and alcoholic beverages, tobacco products, mineral oils and energy products), for all those operating according to the Agreement on excise suspension.


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Table 1. Excise duties on alcoholic beverages in EU STANDARD RATE REDUCED RATE

beer (actual alcoholic strength by volume not exceeding 0.5% vol)80

• €0.748 per hl/degree Plato of finished product, and

• €1.87 per hl/degree of alcohol of finished product

• beer brewed by independent small undertakings producing no more than 200,000 hl

of beer per year • reduced rate should not be more than

50% below the standard national rate of excise duty81

beer82 • for beer with an actual alcoholic strength by volume not exceeding 2.8% vol

still and sparkling wine83 • €0 per hl of product

still and sparkling wine84 • for still and sparkling wine with an

actual alcoholic strength by volume not exceeding 8.5% vol

other still and sparkling fermented beverages85 • €0 per hl of product

other still and sparkling fermented beverages86

• for still and sparkling fermented beverages with an actual alcoholic strength by volume not

exceeding 8.5% vol

intermediate alcoholic beverages87 • €45 per hl of product

• for intermediate alcoholic beverages with an actual alcoholic strength by volume not

exceeding 15% vol • the condition for applying a reduced

rate is that the rate for both should not be more than 40% below the standard national rate of

excise duty and the rate applied to the still wines88.

ethyl alcohol89 • €550 per hl or €1000 per hl of pure alcohol90

• reduced rates should be applied to the ethyl alcohol produced by small distilleries

whose annual production do not exceed 10 hl of pure alcohol.

• those rates should not be more than 50% below the standard national rate of excise

duty91

Source: EU Directives, www.europa.eu.int For all categories of alcoholic beverages, excise rates are reviewed every second year, and if necessary some adjustments are made. If an alcoholic beverage is withdrawn from the market because its condition renders it unfit for human consumption, member states have the right to refund the excise duty paid. EU legislation defines the following conditions that a subject must meet in order to be exempt from the payment of excise duties: o it should be denatured in accordance with the requirements of any member state; o it should be denatured and used for manufacture of products not intended for human

consumption; o it should be used for the production of vinegar, medicines, or flavors for the preparation of

foodstuffs. 2.2. Tobacco products According to the Counsel Directive 95/59/EC, the following types of tobacco products are subject to taxation: o cigarettes; o fine cut tobacco for the rolling of cigarettes; o cigars and cigarillos; o other smoking tobacco. 80 Article 2 of Directive 92/83/EEC and article 6 of Directive 92/84/EEC 81 Article 4.1 of Directive 92/83/EEC 82 Article 5.1 of Directive 92/83/EEC 83 Article 5 of Directive 92/84/EEC 84 Article 9.3 of Directive 92/83/EEC 85 Article 5 of Directive 92/83/EEC and article 15 of Directive 92/86/EEC 86 Article 9.3 of Directive 92/83/EEC 87 article 17 of Directive 92/84/EEC 88 article 18.3 of Directive 92/83/EEC 89 article 3.1 of Directive 92/84/EEC 90 With respect of pure alcohol, member states applying excise over €1000 per hl of pure alcohol may reduce it, but not below €1000. 91 article 22.1 of Directive 92/83/EEC

http://www.europa.eu.int/


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Excise might be: o ad valorem excise calculated on the basis of the maximum retail selling price of each

product; o specific excise, per quantity, or o an excise that combines ad valorem and a specific element. Cigarettes manufactured in the EU, and those imported from non-member states, are subject both to a proportional excise duty calculated on the maximum retail-selling price, including VAT, and to a specific excise duty calculated per unit of the product. The proportional excise duty and the amount of the specific excise should be the same for all cigarettes. Every member state is obligated to apply the proportional minimal excise rate of 57% of the retail price of cigarettes that are most in demand and the minimal excise duty of €60 (€64 as of July 1st of 2006) per 1000 cigarettes, again from the price category of cigarettes that are most in demand. With respect to the approximation of excises on the other tobacco categories other than cigarettes, member states may choose between ad valorem excise, specific excise, or a combination of both. The defined minimal rates are shown in the following table: Table 2. Excise duties on other tobacco products in EU

TOBACCO PRODUCTS EXCISE DUTY

fine cut tobacco for rolling of cigarettes 36% of retail selling price (including all taxes) or € 32 per kg

cigars and cigarillos 5% of retail selling price (including all taxes) or € 11 per 1000 pieces or per kg

other tobacco for smoking 20% of retail selling price (including all taxes) or € 20 per kg

Source: EU Directives, www.europa.eu.int However, the majority of member states that joined the EU on May 1st of 2004 have not reached the minimal excise amounts and, thus, have been given a transitional period until 2010. Hence, the old member states may keep the same quantitative limits for tobacco products imported from the new member states as those that are applied in the case of imports from third countries92. Amendments to Directive 92/79/EC are related to the following: o member states have more freedom in adjusting minimal excise rates in the case of change

of the retail price of the most popular cigarette category; o member states are given the possibility to neutralize the impact of any increase of the

standard VAT rate; o member states who want to postpone the adjustment of the excise burden after an increase

of the VAT rate will be given a period of temporary departure from the principle; o the structure and excise rates are reconsidered every fifth year. The Commission is obliged to publish regular Reports on tobacco taxation. The next Report should be sent to the Counsel during this year and it should take into account all relevant factors. Namely, although excises are primarily an instrument aimed at revenue generation nationally, economic policy in this field will have to consider broader goals. Bearing in mind the characteristics of tobacco products, the Report will pay particular attention to health conditions, especially to the Convention on tobacco control, which was recently agreed with the World Health Organization. In accordance with the principles of a common market, physical persons have greater freedom when purchasing a taxed product for their own use in chosen member states, as well as when transporting them to other member states without the obligation to pay a tax again.

92 With respect to exemptions or return of paid excises on certain tobacco categories, member states are obliged to determine conditions and formalities related to those issues.



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2.3. Energy products The use of tax to achieve environmental goals has been at the center of discussion since the early 1990s. The June 1992 UN Conference on the Environment and Development in Rio (the “Earth Summit”) called for a global strategy to reduce greenhouse gases released into the atmosphere by using economic instruments. The proposal submitted to ECOFIN in 1997 paved the way to the Agreement of the Counsel of Ministers on October 27th of 2003 on the Directive that broadened the scope of Community framework (which had been earlier limited to mineral oils) to all energy products, including coal, natural gas and electricity; the Directive also increased the relevant minimal rates regulated by the Community. The mentioned Directive 2003/96/EC is in accordance with the goals of Community and Kyoto protocol93. In particular, the Directive is designed to: o reduce distortions of competition that currently exist between member states as a result of

divergent tax rates; o reduce distortions of competition between mineral oils and the other energy products that

have not been subject to Community tax legislation up to now; o increase the incentive to use energy more efficiently (so as to reduce dependency on

imported energy and cut carbon dioxide emissions); and o allow member states to offer tax incentives to companies in return for specific undertakings

to reduce emissions. Energy products and electricity are taxed only in the case of their use as motor and heating fuels, and not when they are used as raw products or for the needs of chemical reduction or in electrolytic and metallurgical processes. Table 3 shows the minimal excise rates on energy products. Table 3. Minimal excise rates on energy products

minimal excise rates as of January 1st of 2006 (€)

motor fuel industrial/commercial use94

gas oil used for heating (business use)

gas oil used for heating (non-business use)

petrol(/1000 l) 421 unleaded petrol (/1000 l) 359 diesel 95 (/1000 l) 302 21 21 21 heavy fuel oil (/1000 kg.) 15 15 kerosene 96 (/1000 l) 302 21 0 0 liquid petroleum gas (/1000 l) 125 41 0 0 natural gas (/gigajoule) 2.6 0.3 0.15 0.3 coal and coke (/gigajoule) 0.15 0.3 electricity (/MWh) 0.5 1.0

Note: values are measured at the temperature of 15°C Source : 2003/96/EC Counsel Directive No later than January 1st of 2012, the Counsel should unanimously, after consultations with European Parliament and based on the report and proposal of the Commission, decide on the minimum taxation that will be applied on gas oil beginning January 1st of 2013.

93 Directives 2004/74/EC and 2004/75/EC define legal provisions according to which member states are allowed to apply reduced excise rates on mineral oils with the aim of pursuing specific policies. International Kyoto protocol is the most complex international agreement on the environmental protection, which has been ratified by 150 member states, and according to which they are obliged to reduce the emission of 6 greenhouse gases, especially CO2, until 2012 by at least 5.2% as compared with the level in the atmosphere in 1990. 94 Industrial and commercial use comprises of: agriculture, horticulture, forestry, fixed motors, plants and machinery used in construction, civil engineering and public works, and motors used outside of public roads. 95 As of 1 January 2010, the minimal excise rate on diesel fuels when used as motor fuel will amount to €330/1000 liter. 96 As of 1 January 2010, the minimal excise rate on kerosene when used as motor fuel will amount to €330/1000 liter.

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According to the Directive, member states are allowed to differentiate between commercial and non-commercial use of gas oil, provided that minimal amounts are approved by the Commission and that the excise rate on commercial use of gas oil is not lower than the national rate, which has been in force since January 1st of 2003. This distinction allows member states to reduce the gap between excises applied on non-commercial use of gas oil in cars and the excises on petrol, whereas currently, an argument for a lower excise rate on the use of gas oil in cars does not exist. 3. REGULATION OF EXCISE DUTIES IN MONTENEGRO The Law on excises (“Official Gazette of the Republic of Montenegro”, No. 65/01), which has been put into force on April 1, 2002, determines the excise duty payment obligation for three groups of products: alcohol and alcoholic beverages, tobacco products, and mineral oils and their derivates and substitutes. This Law, followed by numerous sub-legal enactments (which have been gradually put into force after 2002 and which allow for certain transitional periods for some excise products), is almost completely harmonized with EU Directives regulating this field: 92/12/EEC, 92/78/EEC, 92/80 EEC, 92/81/EEC, 98/83/EEC, 92/84/EEC, 92/108/EEC, 92/84/EEC, etc. The excise duty obligation is paid per unit of measurement, except for cigarettes where a combined method of excise duty obligation is applied (specific and ad valorem).

3.1 Alcohol and alcoholic beverages Alcohol and alcoholic beverages, as a group, is comprised of: beer, wine, other fermented beverages, intermediate alcoholic beverages, and ethyl alcohol.

Box 2. Encouraging the use of alternative fuels In November 2001, the European Commission adopted an action plan and two proposals for Directives to foster the use of alternative fuels for transport, starting with the regulatory and fiscal promotion of biofuel as a substitute to petrol. The action plan and proposals for Directives are a function of the realization of goals defined in the Kyoto protocol. The action plan outlines a strategy to achieve a 20% substitution of diesel and gasoline fuels by alternative fuels in the road transport sector by 2020. Biofules (liquid or gas fuel used for transport and products made from biomass) is a gas that might replace traditional gas, or that might be mixed with it from sources such as vegetable oil, sugar turnip, cereals, etc. The Commission considers this technology as the one with the greatest potential in the short and medium term. In that context, requirements for the achievement of sustainable development in the EU highlight the importance of biofuels in conditions of climate changes and development of pure machines. The Commission concludes that only three options would have the potential to achieve individually more than 5% of total transport fuel consumption over the next 20 years: biofuels which are already available, natural gas in the medium term, and hydrogen and fuel cells in the long term. The first proposed Directive was adopted on May 8, 2003. The objective of this Directive is the promotion of the use of biofules, or other renewable fuels, for transport purposes. Member states must ensure that the minimum share of biofuels sold on their markets is 2% by December 31, 2005 at the latest, and 5.75% by December 2010. The second proposed Directive has been incorporated mainly within Article 16 of Directive 2003/96 and provides member states with the option of applying a reduced rate of excise duty to pure or blended biofuels, when used as heating or motor fuel.


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Table 4. Overview of excises on certain categories of alcoholic beverages per hectoliter of beverage

beer97 €1.9 still wine €0

sparkling wine €35 other fermented beverages €40

intermediate alcoholic beverages €70 ethyl alcohol €550

Source: Law on excises, (“Official Gazette of the Republic of Montenegro”, No. 65/01) The type of alcohol and alcoholic beverage depends on their classification, tariff items, and the strength of alcohol within the product. The strength of alcohol is the volume of alcohol in a certain beverage at the temperature of 20°C (sign “vol%”). The basis for excise duty on wine, intermediate alcohol products, and other fermented beverages is the quantity of these products in hectoliters. The excise basis for beer and ethyl alcohol is the volume of alcoholic strength per 1 hectoliter of product. 3.2 Tobacco products Tobacco products, which are subject to excise duty payment, include: cigarettes, cigars, cigarillos, fine cut tobacco for smoking (for rolling of cigarettes) and other tobacco for smoking. As of January 1, 2006, the Law on changes on Excise law has been in force; according to this law, the excise duty on tobacco is a combination of a specific excise, for all cigarettes, both domestic and imported (€1.00 €/kg, which is 0.02 €/pack) and a proportional excise amounting to 26% of the retail price (including excise and VAT). With this law, the previous legal decision, which determined the excise on tobacco dependent on the quality of the group of cigarettes, was repealed. As for other tobacco products, the current excise is kept and it is paid according to quantity, amounting to: o €10.00 per kg for cigars and cigarillos; o €20.00 per kg for fine cut smoking tobacco (for rolling of cigarettes); o €15.00 per kg for other smoking tobacco. In order to gradually adjust the excise amount on tobacco with the lowest amount in the EU, the Government is authorized to increase, by law, the determined excise duty up to 20% annually. The percentage increase would depend on the excise amount paid on the most popular cigarettes. Namely, according to the EU Directives, the lowest level of excise duty on cigarettes is 57% of the retail price of the most popular cigarette in the country, and as of 2006, that amount cannot be below €64 per kg. Also, as of January 1, 2006, the Decree on Change of the Excise Calculation and Payment Manner in Tobacco Product Trade with the Republic of Serbia has been in force (Official Gazette of the Republic of Montenegro, No 82/05). According to this decree, the excise is not calculated nor paid in our Republic for tobacco products sold to buyers from the territory of the Republic of Serbia, but rather, the excise is calculated and paid for the tobacco products procured from the territory of Serbia as if these were imported products. 3.3 Mineral oils, their derivatives and substitutes According to the Excise Law, mineral oils is a category comprised of petroleum oil, coal tar, and crude oil derived from coal slates or some other bituminous substance, not including carbon-hydrogen or a bituminous substance that is in a solid or semi-solid shape at the temperature of

97 Excise duty amounts to € 1.90 per volume of alcoholic strength per hectoliter of beer and it is applied on each category of beer whose strength of alcohol exceeds 0.5% vol. As of January 1, 2005, the excise duty for natural brandy is €100 per hectoliter of pure alcohol.

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15°C or in a gas shape at the temperature of 15°C and under pressure of 1013.25 milibars98. Mineral oils also relate to the products used as motor fuel, additives added to the motor fuel, and any other carbon-hydrogen produced from crude oil and used as heating fuel, except for black coal, lignite, peats, or biomass. Excises on additives to mineral oils are equal to the excise on the mineral oil to which they are added. The basis for excise duty payment is the quantity of mineral oils expressed per kilogram or liter. If the quantitative measurement for excise is in liters, they are measured at the temperature of +15°C. Table 5. Excise on mineral oils, their derivatives and substitutes

PETROL AND OTHER LIGHT OILS KEROSENE GAS OILS HEATING OILS

CRUDE OIL GASES AND OTHER GAS CARBON-

HYDROGEN

€0.120/kg of air craft fuel

€0.120/kg of petroleum

(kerosene) for motors

€0.270/lit of diesel fuel

€0.023/kg of low-sulphur oil for

metallurgy

€0.069/kg of mixture of propane and butane

€0.120/kg of fuels for ramjets of petrol

type

€0.120/kg of fuel for ramjets of petroleum

type

€0.120/lit of diesel fuel used as heating

fuel

€0.023/kg of other heating oils

€0.069/kg of other crude oil gases

€0.364/lit of motor unleaded petrol

€0.120/kg of other kerosene

€0.270/lit of fuels for ships and other fuel

€0.364/lit of other motor petrol

€0.069/kg of fuels for ramjets of

petroleum type

€0.120/lit of other oils

Source: Law on excises The Government has a right to decrease the excise duty in the case of market fluctuations caused by a significant increase in the price of mineral oils,; but, that increase should not be higher than 20%. Also, in the case of a decreased price of mineral oils at the world market, the Government may increase the excise duty in the amount by which they were reduced. The proposed solution creates the possibility to influence macroeconomic stability in the country through tax policy. 3.4 Overview of budget revenues from excises in Montenegro Strengthening of the Montenegrin economy in recent years, together with the change in the structure of tax revenues in terms of increasing indirect tax revenues, require as well an increase of excise duty revenues. After VAT revenues, revenues from excise duties represent the second largest revenue category in the republic budget with an average share of 16% in total revenues. Since the introduction of the current Law on excises, excise duties have constantly increased their share in the budget over the last three years. At the end of 2005, revenues from excises amounted to €65.60 million and were approximately 7% higher than both the planned amount and the previous year’s execution. For 2006, excise revenues are planned to reach €77.55 million, which is 26.6% higher than the planned amount in 2005. The planned amount of excises represents 18.3% of total planned tax revenues in 2006. Since the rule book on uniform classification of accounts for the republic budget, extra-budgetary funds, and budgets of municipalities was adopted in 2006, a portion of the excises paid on imports (excises on crude oil derivatives), which was earlier used by the Department for construction of roads as their revenue, now represents revenue of the republic budget.

98 Mineral oils used for heating cannot be put into circulation on petrol stations or other retail sale places of crude oil products.


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Graph 1. Excise revenues in period 2002-2005.(€ millions)

0

10

20

30

40

50

60

70

2002 2003 2004 2005

excises paid in production excises paid in the import

Source: Ministry of Finance In depth analysis finds that excise revenues (paid in production and import) are increasing every year (showed in graph 1), contributing to the significant change in the structure of revenues on this basis. Namely, revenues from excises paid in production increased their share in budget revenues from 8.9% in 2002 to 22.1% in 2005. At the same time, that impacted a decrease of the relative share of revenues from excises paid on imports (with their constant absolute increase) from 91.13% in 2002 to 77.7% in 2005. This indicator, points to an increase of production and a decrease of the gray economy in this field in Montenegro with the simultaneous decrease of its import dependency with respect to these product categories. The greatest share (85%) of excise revenues comes from excises on mineral oils, their derivatives and substitutes, mainly from import; while a small percentage, about 3%, relates to domestic production. In this way, revenues from excises on mineral oils generate 96% of revenues from excises paid in imports. ISSP analyses show that planned revenues from excises on mineral oils, their derivatives and substitutes in 2006 would be achieved even with a decrease of the average excise burden on this category by 5-6%. Such an outcome with a lower tax burden would give spare room for an increase of revenues on this basis in 2007, primarily via the broadening of the tax base and the entrance of a greater number of producers and importers of mineral oils, their derivatives and substitutes in the legal channels. A possible decrease of the excise duty on mineral oils, their derivatives and substitutes is primarily related to petrol and other light and gas oils, for the excise burden on these products is pretty high as compared to more developed countries. Also, because of the fact that Montenegro’s public transport totally relies on petrol and diesel fuel, the Montenegrin people feel the negative consequences of high excise duties, while the producers and importers of petrol and other light and gas oils enter illegal channels, directly creating a decrease of budget revenues. Hence, with respect to this excise category, there is room to decrease the excise burden in Montenegro. Excises on tobacco have a share of about 11.1% in total excise revenues, out of which 77.5% is related to excises paid in production and about 22% in import. The lowest share of excise revenues is earned from the payment of excises on alcohol and alcoholic beverages (8.4%).

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4. CONCLUSION The most recent changes in the field of excise regulation significantly brought this part of Montenegrin tax legislation closer to the standards issued by the EU. This conclusion is especially applied to the change in the way in which excises on tobacco are calculated and paid99, thus creating positive expectations regarding the lower scope of the gray economy. Certainly, further improvements to excise regulations are expected in the future -- for all product categories that are subject to excise duties. In the future, Montenegro should pay particular attention to broadening the scope of taxation of energy products (coal, natural gas and electricity). Additionally, bearing in mind the fact that Montenegro is an ecological state, in the process of preparing the economy for joining the EU it is necessary to make significant efforts to promote the use of alternative fuel as a substitute to petrol. Preparation of a clear strategy and definition of realistic goals, together with the selection of appropriate instruments, could provide Montenegro with the leader position regarding the fiscal and regulatory promotion of the use of natural or other types of renewable fuel. Under the conditions in which all of Europe is trying to change and restructure its consumption, the adoption of “clear” energy technologies will soon become one of the imperatives of the modern development of Montenegro. LITERATURE 1. Sophia Delipalla and Owen O’Donnell:” The comparison between ad valorem and specific taxation

under imperfect competition: evidence from the european cigarette industry”, IMF Working paper 2. Kay, J.A. and M.J. Keen, 1983, How should commodities be taxed?, European Economic Review 23,

339-358. 3. Kay, J.A. and M.J. Keen, 1987a, Commodity taxation for maximum revenue, Public Finance Quarterly

15, 371-385. 4. Kay, J.A. and M.J. Keen, 1987b, Alcohol and tobacco excises: Criteria for harmonisation, in SCnossen,

eds., Tax coordination in the European Community (Kluwer Law and Taxation, Deventer). 5. Ilić G., Popov Đ.:Lexicon of public finance,Belgrade, 2003 6. The Law on excises (“Official Gazette of the Republic of Montenegro”, No. 65/01) 7. www.europa.eu.int 8. http://epp.eurostat.cec.eu.int 9. www.vlada.cg.yu

99 Now, excise is calculated when excise stamps are received by Tax administration and it is paid within 60 days from the day they were received (for the total value of stamps) and this solution is related both to the imported and domestically produced cigarettes.


http://epp.eurostat.cec.eu.int/

http://www.vlada.cg.yu/


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TAXES AND ECONOMIC FREEDOM Author: Msci Jelena Zvizdojević, CARA

I INTRODUCTION In economic literature, Adam Smith was the first to accentuate the importance of economic freedom. He concluded that Great Britain and Holland prospered faster than other countries because they had a higher level of economic freedom. Today, the majority of economists agree that economic freedom represents the main precondition of economic development of a country. The essence of economic freedom affirms: own choice, property rights, and freedom of agreement. The economic freedoms of individuals are not without limits. The government, through different forms of regulation, has limited the discretion of individuals to use their own freedom. By regulation the state implements basic rules that present public good that owns its price as well. One form of regulation is taxes. Taxes represent a limitation of economic freedom because they not satisfied a concept of the willingness on the market. Taxes do pose the question, what limitations do taxes represent for economic freedom and what is their impact on the economic development of a country? II ECONOMIC FREEDOM The institutions that have analyzed economic freedom gave two basic definitions of economic freedom: Heritage Foundation: “Economic freedom is defined as the absence of government coercion or constraint on the production, distribution, or consumption of goods and services beyond the extent necessary for citizens to protect and maintain liberty itself.” Fraser Institute: “An individual has economic freedom if ownership earned without using force, tricks, or pinch, and protected from corporal harm from other individuals. Also economic freedom is defined as being built upon personal choice, a voluntary exchange, the right to keep what you earn, and the security of your property rights.” An individual is economically free if no one intentionally hinders his economic transactions with other individuals on the market. The greater the absence of limitations is the wider the economic freedom of individuals.100 The role of the state, in the concept of economic freedom, does include the protection of contract, rule of law, the procurement of public goods, establishing freedom of international trade and transactions, and a low level of business regulation. Any involvement of the state outside of these areas would represent destruction or a reduction of economic freedom. The Heritage foundation and the Fraser Institute use the index of economic liberty to measure Economic Freedom. The most significant indicators of economic freedom, according to these two institutions, are fiscal limitations (e.g. taxes and government consumption), openness of trade policy, the strength of property rights, monetary policy, inflation rate, level of business regulation, the level of domestic and foreign investments, freedom of wage and price setting, level of gray economy, etc. Based on their level of economic freedom, each country is rated, using a scale of 1 to 5 (at the Heritage Foundation) and a scale of 1 to 10 (at the Fraser Institute, EFW Index).

100 Source: Miroslav Prokopijević, “Economic freedom and economic growth”

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The Heritage Foundation identifies their ratings as such: if a country receives a 1.95 or less, it considered free, from 2 to 2.95 mostly free, from 3 to 3.95 mostly not free, and if the score is higher than 4 the country is not free. The Fraser Institute identifies their ratings as such: from 8 to 10 a country is considered free, from 6 to 7.99 a country is considered to be mostly free, from 4 to 5.99 the country is mostly not free, and from 0 to 3.99 the country is not free101. The reason for measuring economic freedom is to calculate their effect (the effect of the indicators that are comprised in the index of economic freedom) on the growth and development of a country, as well as the influence on other variables that influence the prosperity of a country. According to a great deal of research related to the correlation of economic freedom and economic results, economic freedom is responsible for 52% to 75% of the achieved growth rates, while other factors (geographic location, presence of capital, know how, qualified workforce, etc.) are responsible for the other 48% to 25%102. The graph below presents the level of economic development’s dependence on the level of economic freedom. All countries are divided into five groups (I, II, III, IV and V) according to their level of Economic Freedom identified by the Fraser Institute, i.e. EFW Index. Group I includes one-fifth of the countries in total, those with the lowest level of economic freedom, while Group V includes the fifth of the countries that have the highest level of economic freedom. Graph 1. Economic Freedom and economic growth

0.50

1.90 2.00 2.10

2.40

0

0.5

1

1.5

2

2.5

3

I II III IV V

Source: Kavarić Vladimir, “Institutions, rules and economic freedom”, Master thesis, page 59. We can conclude from the graph that growth rates are much higher in the countries that have a higher level of Economic Freedom. The level of economic freedom mostly determines gross domestic product of a country. Still the “introduction” of economic freedom in the short term will not yield high growth rates of the GDP. It is necessary that economic freedom be a long-term goal of a country, which is the government, in order to see the positive effects. The best example of this is Ireland (among one of the most economically liberal countries in the world), which went from being one of the most underdeveloped countries in the EU25 to the second most developed country, just below Luxemburg.103

101 Disregarding methodological differences between EFW (Economic Freedom of the World) and Heritage indices, both are highly correlated here. 102 Source Hankie & Walters 1997 103 Index of Economic Freedom 2006, Heritage foundation, for Ireland 1.58, while in 1995. it was 2.20

Economic Freedom

Econ

omic

Gro

wth


130


III TAXES AND ECONOMIC FREEDOM Functions of the state are not free, and for every job that needs to be done certain expenses must be met; for these expenses, the state compensates by collecting taxes from the citizens. Higher taxes mean lower economic freedom because they do not represent the result of a voluntary market exchange. By increasing taxes, the level of income available to citizens (investors) is lowered and their motivation to work and invest is also lowered. A higher level of taxes encourages entrepreneurs/companies to do business in the black market (gray economy) because in doing so, they avoid the payment of taxes, and the debt towards the state is reinvested in the black market. Lower economic growth and development One of the indicators that are in the Index of Economic Freedom is the “fiscal burden of the state,” which basically means the level of taxes. The Heritage foundation rates fiscal burdens on this basis: income taxes, corporate taxes, and annual changes of state expenditure. Income tax up to 10% is rated 1, between 10% and 20% is 1.5, between 20% and 25% is 2, continuing in this pattern to between 45% and 50% is 4.5, and above 50% is a 5. Corporate tax rate up to 15% is rated 1, between 15% and 18% is 1.5, between 18% and 21% is 2, … between 33% and 36% is 4.5, and above 36% is a 5. An annual change of government expenditure up to -4% of GDP is rated 1, between - 4% and -3% of GDP is 1.5, between -2% and -1% of GDP is 2.5 … between 2% and 3% of GDP is 4.5, and above 3% of GDP is a 5.

Higher taxes

Higher level of gray economy

Lower level of investments

Lower level of economic freedom

Monet June 2006


Table 1. Five countries with the lowest index for fiscal restrictions and their Index of Economic Freedom

Country Fiscal restrictions Economic Freedom

Bahrain 1.3 2.23 Bahrain United Arab Emirates 1.3 2.93 United Arab Emirates

Kuwait 1.4 2.74 Kuwait Saudi Arabia 1.4 284 Saudi Arabia Macedonia 1.5 2.80 Macedonia

Source: Index of Economic Freedom 2006, Heritage Foundation Bahrain, United Arab Emirates, Kuwait and Saudi Arabia have no income tax, as well as no corporate tax; in Macedonia, the income tax rate is 24% and the corporate tax rate is 15%. Behind the level of tax rates, the tax regime is also very important. In 2003, according to their fiscal restrictions, Romania took 47th place, and according to the Index of Economic Freedom in 2006, it takes 9th place. This change is due to the fact that in January of 2005 Romania implemented a proportional tax regime with a value of 16% (income tax rate as well as corporate tax rate). Under the concept of economic freedom, proportional taxation represents the best tax mechanism because those that work more and earn more are not being “punished”. IV TAXES AND ECONOMIC FREEDOM IN MONTENEGRO In none countries, unless countries rich with oil, have no prosperity without the prosperity of a private economy. Prosperity is only possible when domestic, and afterwards foreign, investments rise. Domestic investors are a signal that the market is functioning well and that there are means for the coming of foreign investments. The role of the state in the entire process – investment augmentation – is very significant and it is seen in the creation of stimulant conditions for private investments and their controlling of the rules of the game. One of the stimulant conditions is the level of taxes. In April 2003, the sales tax was changed when the Value Added Tax (VAT) was implemented; the previous rates, of the sales tax, were 12% for services and 24% for goods. VAT was implemented with a flat rate of 17%104. In the 2005 this uniqueness flat rate (VAT) has been modified for some products: rates of 7% were given for products that had previously had a 0% VAT (dairy products, sugar, bread…). Also in the beginning of 2006, in the aim of promoting the development of tourism, the VAT for everything in the tourism sector was lowered from 17% to 7%. During 2004 the government lowered tax burdens for private companies. Twice employees’ income tax was lowered by 5%, and now these taxes range from 15% to 23%, which implies that it is still a progressive tax rate105. The very same year the corporate tax rate was lowered from 20% to 9%, and with that, Montenegro has the lowest rate in the region. On the basis of tax rates, according to the Heritage foundation, income tax is rated a 2, which represents a “medium level of tax rates”, while corporate tax rate is rated a 1, which represents a “very low level of tax rates”106. According to the concept of economic freedom, the level of taxes in Montenegro is a good solution, especially for the corporate tax rate and for proportional taxation. What would certainly be a leap in quality is a proportional rate for income taxes and the removal of taxes on reinvested profits.

104The introduction of VAT has led to the reduction of the gray economy. 105 Still, Montenegro has one of the highest income tax rates of the countries in the region 106 Source: Vladimir Kavarić “Institutions, rules and economic freedom”, Master thesis, Podgorica 2005


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All in all, according to the Index of Economic Freedom of the Heritage foundation and the Wall Street Journal, Montenegro holds the 81st position on the world list, with a mark of 3.1, which qualifies it as a “mostly not free” country. Together with Montenegro, Namibia and Qatar are ranked as well. Above Montenegro, in 79th place with 0.2 points more, are Sri Lanka and Guiana, while below Montenegro, in 83rd place with 0.4 points less, is Tunis.107 V CONCLUSION Growth and development of a country is substantially defined by its level of economic freedom. Experiences of many countries show that higher levels of economic freedom have led to higher investment. For example, in the period from 1980 to 2000, the level of investment per employer in an “economically free” country was approximately 12 times higher than in countries with less economic freedom. In Montenegro, in order to increase the level of investment, we must continue to work towards decreasing tax rates and include proportional taxation; this will lead to a higher level of economic freedom. A higher level of economic freedom is conducive to long term economic growth and prosperity. LITERATURE 1. Kavarić Vladimir, “Institutions, rules and economic freedom”, Master thesis, Podgorica 2005 2. Prokopijević Miroslav, “Constitutional economic”, E Press, Beograd 2000 3. Prokopijević Miroslav, “About economic freedom – Politic and freedom”, IDN, Beograd 2003 4. Vukotić Veselin, “Psychophilosophy of business”, CID, Podgorica 2003 5. James D. Gwartney i Robert A. Lawson, “Economic Freedom of the World 2003 Annual Report”, The

Fraser Institute, Vancouver, Canada 2003 6. James D. Gwartney i Richard L. Stroup, “What everybody needs to know about economic freedom

and prosperity”, IEDM 1993 7. www.heritage.org 8. www.fraserinstitute.ca 9. www.freetheworld.com

107 Source: Vladimir Kavarić “Institutions, rules and economic freedom”, Master thesis, Podgorica 2005

http://www.heritage.org/

http://www.fraserinstitute.ca/

http://www.freetheworld.com/

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IMPLEMENTATION OF REDUCED VAT108 RATE IN TOURISM SECTOR Author: Nataša Masoničić, ISSP

I INTRODUCTION As on every market, the price of a service is formed as a result of the relationship between supply and demand on the tourism market as well. The price of a tourism offer, among other elements, also includes duties that have to be paid to the state (various taxes and levies), which make the offer either more or less competitive on the international market. If the main strategic sector in Montenegro’s long-term perspective is tourism, we must question whether the tourism offer should be taxed or if the state should make it more competitive by making it tax exempt? A businessman operating in tourism who is tax-exempt has the opportunity to lower his price to attract more tourists, and by using economies of scale, he can accumulate resources to increase the quality of his offer. In the long term, that creates the opportunity to attract high spending guests, as well as to increase income in terms of the overall economy. The previous tax regime does not encourage foreign tour operators to include Montenegro in their tour packages; thus, foreign tourists have been withdrawn from visiting our country, while at the same time, domestic tour operators are punished. These tax regimes have a negative impact on the price competitiveness of Montenegrin tourism products. Not only do they discourage the influx of foreign tourists and price competitiveness, but they also lead to the unequal treatment of tourist product export through allocations from abroad (they should be treated in the same way as the export of other products and services, in other words, no VAT rate should be applied on them). II TOURISM AND VAT 2.1. European Union (EU) The current tax regime in the European Union is characterized by various standard rates among countries. The unique European rule that is currently applied has a minimal regular rate of 15.0%. In most countries these rates are very different, from 15.0% in Luxembourg up to 25.0% in Sweden and Denmark. Most countries have one or two reduced VAT rates; these are also very different among EU member countries. Some countries apply no VAT rate (or absolute exemption) on some products; for example Great Britain and Ireland apply no VAT on certain products, while Italy and Luxemburg apply a “super reduced” rate (4.0% in Italy and 3.0% in Luxemburg). According to data from 2004, ten out of fifteen EU members, as well as nine out of ten accessing countries, apply (and will apply in the future) reduced rates on accommodation services. Additionally, thirteen out of twenty five countries already apply or are planning to apply reduced VAT rates on restaurant services. In order to create a common market, EU member countries have coordinated its Fiscal Policies. The European Commission proposed the creation of a unique VAT regime in Europe, under the postulate that euro implementation will increase transparency as well as competition on the common market. In principle, according to the European Commission resolutions, the reduced rate is applied only on some products and services (Annexes H and K of Sixth Directive 77/388/EEC – May 13, Value Added Tax


134


1977) that have been proven by practice examples. The reduced rate is considered to be optimal from the EU perspective. Hotels are also included in Annex H, which means that the reduced rate also applies to them. However, restaurants are not considered in either Annex H or in Annex K, therefore, the reduced rate will not apply to them in the future common VAT regime. Among the EU countries, Denmark, Germany (other than “take away” food) and Great Britain do not apply reduced rates on the main sub-sectors in the field of catering. Almost all other countries apply the regime of reduced or even “super reduced” rates in this sector, with the exemption of alcoholic beverages and nightclubs. Luxemburg, Portugal, and Spain apply a reduced VAT rate on all segments of the catering sector, including alcoholic beverages and nightclubs, thereby using that as a tool to stress the importance of tourism to its overall economy. 2.2. Montenegro The usage of the VAT regime in Montenegro began on April 1, 2003. From that moment, according to the Law on VAT, the unique positive rate of 17.0% was applied on all taxable inputs. The application of the unique VAT rate of 17.0% seriously deteriorated the position of tourism, which is considered to be one of the development priorities in Montenegro. As a solution, implementation of a reduced VAT rate on foreign arrangements, hotel services, hotel equipment, import, etc. was proposed. The main reason for reducing the VAT rate is that the Montenegrin Law on VAT was created to stimulate export and excuse them from paying VAT; however, the Law does not recognize foreign tourist circulation as export activity. According to EU rules however, services in tourism, catering, and hotels are considered export activities. Namely, foreign travel agencies that prepay for accommodations, transport and many other services in Montenegro to establish tour packages are not exempt from paying VAT; thus, they have little interest to include Montenegro in their tourist offers. Additionally, their tax regimes imply penalties for domestic agencies that are involved in bringing in tourism that has a negative impact on the price competition of Montenegrin tourist products. It is also important to mention that with the introduction of VAT in 2003, all services that were previously non-taxable began to apply VAT, with the exception of residence tax and insurance. Also, a reduced VAT rate should be introduced because of the influx of employees in tourism, as well as in catering. Also, the decreased prices of hotel and restaurant services will result in increased demand and consumption. Hotels and restaurants in Montenegro, according to the regulations of the Law on VAT, are not included in the reduced VAT rate, even if hotel services are involved in Annex H 92/77 of the EU Directive on VAT that allows EU countries to apply a reduced VAT rate on hotel services. III WHY REDUCED VAT RATE? Implementation of a reduced VAT rate in the tourism sector in Montenegro would primarily provide fair conditions for their international market competition. Namely, all of the competitive European countries, Italy, Portugal, Turkey, Greece, and Spain apply a reduced VAT rate from 6-8.0% in the tourism sector. The implementation of the proclaimed reduced VAT rate of 7.0% in the tourism sector, from the beginning of the current year, will put the Montenegrin tourist offer in equal position (in the sense of this issue) with the mentioned countries.

Monet June 2006


A reduced VAT rate in the tourism sector, which is a very price sensitive sector, can provide a price reduction and therefore create the opportunity for tourism businesses to reply adequately to price competition. A high elasticity level also characterizes this sector109. For example, a demand/price elasticity of -2.5 means that a price cut of 10.0% would stimulate a 25.0% increase in the volume of demand for tourism. A Deloitte and Touche Study in 1995 for the British Tourist Authority established that price elasticity in tourism might reach -2.5%. Also, while mentioning the reasons for implementation of a reduced VAT in the tourism sector, the importance of this sector for Montenegro’s overall economic development should be taken into consideration, as well as the fact that despite high growth rates, this sector has a pretty low profit margin. One of the main reasons to apply a reduced VAT rate in the tourism and catering sector is the high influx of work force. Although the sector employs a number of highly qualified workers, it is also a source of employment for the less skilled. It provides them with a working experience that will teach them the necessary skills for our sector, but many of these skills are also useful for work in other sectors. Thus, it provides many young people with their first professional experience allowing them to enter the working world. The sector opens the door to future jobs. Similarly, the sector helps the unemployed to reintegrate into the working environment. It also offers many (parents, students, rural workers, etc.) the flexibility of having a part-time job, which allows them to pursue their other activities. Additionally, the implementation of a reduced VAT rate will also create new working places as a result of increased demand generated by price reductions because of the lower VAT rate.

Box 1. The experiences of several countries show that there is a high correlation between tourism VAT rate and employment Portugal. The preamble to Directive 2000/17/EC on transitional provisions granted to the Portuguese Republic stated “The Portuguese Republic wishes to reintroduce a reduced rate on these services (restaurants) on the basis that maintaining the normal rate had adverse consequences, in particular job losses and an increase in undeclared employment, and that application of the normal rate increased the price of restaurant services for the final consumer.” Norway. In 2000, the Norwegian Government announced that VAT would be imposed on hotel services, which had been exempted from VAT so far. As a result, the prices of hotel services would have increased tremendously (by the equivalent of a wage increase of 24%). Calculations showed that the increased prices would have led to a reduction of consumption of such services, with a sharp decline of employment in the sector. Fortunately the sector managed to persuade the Government to maintain the VAT exemption for hotel services. Netherlands. The Netherlands experienced a rise in VAT on hotels and restaurants in 1969. That year remains in Dutch memory as a disaster year for tourism: turnover decreased by 4.0%, prices rose by 7.0% and the tourism balance deteriorated by 12.0%. Since 1971 the reduced rate has applied to most services in accommodation and catering. The Dutch Board for the hotel and catering industry has calculated that the introduction of the standard rate in this sector would have dramatic consequences, with the loss of approximately 17,000 jobs. Ireland. In the beginning of the 1980s VAT on hotel accommodation rose from 10.0% to 23.0%. This had a dramatic effect on the hotel industry in the country with more than 10% of the hotels closing their doors. Then the authorities decided to reduce the VAT rate on accommodation and meals in March 1985 and July 1986 respectively. This cut greatly contributed to the growth of the hotel and catering industry in Ireland.

Source: www.hotrec.org

109 The measure of correlation between two variables.


136


A reduced VAT rate in the tourism sector should be used in Montenegro, especially in regards to its major competitors, the tourist offer of Bulgaria and Croatia. This is very important, because currently in these countries there are numerous debates about a possible increase of the present VAT rates on tourist services, which could result in a very unfavorable position of these countries as compared to their competitors.

Box 2. Bulgaria and Croatia, will tourism lose its preferential status? Bulgaria. Bulgaria’s tourist sector stands only a slim chance for preserving its preferential value added tax (VAT) treatment for selling tour packages to foreigners. Currently, Bulgaria charges only seven per cent VAT on tourist packages for foreigners (with the most controversial point being hotel accommodations). However, in line with its commitments to the European Union (EU), the country will have to raise the rate to 20.0%, which is the uniform rate for all goods and services in Bulgaria. An increase to 20.0% in the VAT rate for hotels, for instance, will increase prices by more than 13.0%, discouraging customers. About 80.0% of foreign visitors come to Bulgaria through foreign tour operators and their packages of hotel, food and other services currently include 7.0% VAT. If prices increase by 13 per cent next season, hotels will face quite serious problems. Their sales will slump or expenses will surge. In both cases, hotels may be forced to stop operating, as they will be unable to cover their costs and repay investment. Croatia. By reducing the support of reduced travel costs of foreign tourists in Croatia in 2006, as one of the commitments to the EU, and also the abolition of no VAT rate for tourist services offered to foreign tourists, the profitability in this sector is significantly endangered. The abolition of no VAT rate resulted in a 20-30.0% increase, and therefore reduced the number of reservations, and will probably affect the overall number of overnights for the whole year. With the changes in the Law on VAT, abolishing the no VAT rate on organized stay of foreign tourists, the VAT rates for domestic and foreign tourists are made equal. For all services in the tourism sector, the uniform VAT rate is 10.0%, since the beginning of the current year..

A very important problem mentioned by small tourist agencies in Montenegro is related to the situation when those agencies act as agents in selling accommodation services in private houses. The agent has to calculate its fee as well as VAT on the price of the private accommodation (with no possibility to discount the previously added VAT, because that VAT does not exist since the accommodation owners are small taxpayers and therefore have no obligation to pay it). On the other hand, tourists taught by experience, tend to outflank agents and rent accommodation directly from owners. This problem will also appear in other countries, and VAT itself cannot resolve it. Travel agencies and their associations depend on the “game rules” with private accommodation owners being defined, and if they are, a variety of services will be increased and they will avoid reliance on only one income source. However, many of the questions regarding taxation are not directly connected to the level of VAT, but rather to the gray economy in the tourism and catering sector. Restaurants, bars, small hotels, and private objects, are highly liable if caught avoiding paying taxes because of the nature of transactions (mainly in cash), combination of private and commercial interests and usages, as well as of the small operating scope that is very often an additional income source. The main issue here is that by applying a favorable tax and other treatments we can inspire these economic entities to transform into legal ways of operating. IV CONCLUSION Catering and hotel services are the main tourism components. When discussing VAT, at one side there is the role of this kind of tax in collecting tax revenues for the Government, and on another side there is the economic role of tourism in the framework of national interests, regardless of whether they are internal, cultural, or historical issues, or simply important for international relations.

Monet June 2006


Generally, it is very hard to evaluate the overall effects of the implementation of VAT on tourism, but recent examples have shown that overall public incomes from direct and indirect taxes, as well as contributions for social insurance, should be taken into consideration when establishing the VAT rate. Until now, the majority of surveys and case studies have shown that a low VAT rate can increase demand, and therefore increase overall Government income of the tourism sector, because a lower income from VAT is compensated by higher incomes of profit and income tax, as well as other kinds of direct taxes. Implementation and usage of a reduced VAT rate for accommodation, and possibly for restaurant services, in Montenegro can result in a lower price and therefore increase demand. However, if prices did not change, positive effects would not be realized. Because of political and economic environment, the tourist season is still pretty short and hotel owners and other taxpayers cannot adequately keep their objects; and there is a noted lack of investments. Reduced VAT rates can eventually help Management to increase the quality of their service. Because of that, the Montenegrin Government reviewed its Tax Policy and decided to implement a reduced VAT rate from the beginning of the current year. Implementation of a lower VAT rate for accommodation services in tourism represents a great impulse for further development of tourism in Montenegro. According to the changes and amendments of the Law on VAT, the lower rate of 7.0% for accommodation services became valid as of the beginning of 2006. The real effects of this decision will be visible at the end of this tourist season, which started much earlier this year as compared to previous years, leaving some hotels with up to six months in their tourist season.


138


STATISTICAL ANEX

Monet June 2006


REAL SECTOR Table 1: Major developments in the Real sector

GDP Industrial production Touism Transport

Processing industry **

Transport of passengers

Transport of goods

1991

=10

0

Annu

al c

hang

e in

%

2000

=10

0

Annu

al c

hang

e in

%

2000

=10

0

Annu

al

chan

ge in

%

Alum

inum

pr

oduc

tion

(ton

)

Elec

tric

ity

gene

ratio

n (in

M

Wh)

pers

ons

Annu

al c

hang

e in

%

Shar

e of

for

eign

to

uris

ts in

tot

al in

%

1998

=10

0

Annu

al

chan

ge in

%

1998

=10

0

Annu

al

chan

ge in

%

2000 84.1 3.1 100.0 3.3 100.0 95,526 2,698,019 448,187 99.3 18.7 66.2 -18.2

2001 83.9 -0.2 98.0 -2.0 101.6 1.6 108,123 2,492,993 555,040 23.8 82.0 -17.4 69.1 4.5

2002 85.3 1.7 98.7 0.7 103.9 2.3 116,482 2,194,516 541,699 -2.4 25.1 65.2 -20.6 83.1 20.2

2003 86.6 1.5 100.9 2.2 104.6 0.6 120,212 2,586,420 598,539 10.5 23.6 67.3 3.3 81.2 -2.4

2004 89.8 3.7 114.6 13.8 120.8 15.6 120,796 3,246,608 703,484 17.5 27.0 64.4 -4.4 76.8 -5.4

2005 93.8 4.5 112.4 -1.9 123.8 2.5 120,373 3,231,331 820,457 17.0 37.6 62.3 -3.2 79.9 3.7

2002-Q1 88.0 -24.7 26,619 507,743 33,292 50.9 -14.7 84.5 80.3

2002-Q2 89.0 -23.7 29,513 265,271 118,958 61.4 -14.0 67.1 -18.1

2002-Q3 101.0 -13.2 30,105 501,282 352,718 88.4 -27.5 72.1 14.6

2002-Q4 116.7 2.6 30,245 920,220 36,731 59.9 -20.0 108.8 28.3

2003-Q1 108.5 23.3 104.4 29,744 1,010,097 26,913 -19.2 21.7 45.7 -10.2 63.8 -24.5

2003-Q2 87.9 -1.2 105.9 29,988 377,521 123,180 3.5 27.5 62.3 1.4 81.8 21.9

2003-Q3 98.1 -2.9 99.2 30,176 458,240 420,910 19.3 25.0 104.5 18.2 85.5 18.6

2003-Q4 106.8 -8.5 108.7 30,304 740,562 27,536 -25.0 29.5 56.8 -5.1 93.5 -14.0

2004-Q1 106.6 -1.7 111.3 6.6 30,168 840,947 26,265 -2.4 42.1 47.4 3.8 72.5 13.7

2004-Q2 117.5 33.6 121.0 14.3 29,783 981,060 121,790 -1.1 34.0 60.3 -3.3 70.7 -13.7

2004-Q3 104.7 6.7 113.8 14.7 30,335 518,626 512,740 21.8 26.0 98.3 -5.9 83.3 -2.6

2004-Q4 129.4 21.2 139.0 27.9 30,510 905,975 38,809 40.9 38.2 51.4 -9.6 80.7 -13.7

2005-Q1 110.94 4.0 115.5 3.8 29,951 1,388,921 29,154 11.0 34.4 41.0 -13.6 61.1 -15.7

2005-Q2 109.26 -7.0 119.3 -1.4 29,709 636,208 149,116 22.4 37.9 55.83 -7.4 77.56 9.8

2005-Q3 117.76 12.5 155.9 37.0 30,346 451,467 598,182 16.7 32.8 91.3 -7.2 88.8 6.7

2005-Q4 116.94 -9.6 128.9 -7.3 30,367 754,735 44,005 13.4 40.5 61.1 19.0 92.1 14.1

2006-Q1 116.02 4.4 112.4 -2.7 1,004,210 40,003 37.2 39.0 44.2 7.9 80.3 31.3

Jan-04 99.67 -0.1 80.2 10,274 275,727 6,578 -30.9 23.7

Feb-04 109.04 -3.5 115.5 -1.8 9,588 340,680 14,318 50.4 47.6

Mar-04 111.55 -1.1 131.0 14.9 10,305 224,540 5,369 -31.8 55.0

Apr-04 119.35 44.6 113.3 22.4 9,846 327,487 14,198 2.9 33.5

Maj-04 116.73 46.0 123.4 15.2 10,091 382,956 43,697 16.7 36.1

Jun-04 116.38 16.5 124.3 5.30 9,846 270,617 63,895 -11.2 32.5

Jul-04 105.56 6.1 108.8 13.00 10,291 158,113 177,957 -2.7 22.7

Avg-04 99.01 0.2 112.2 16.50 10,174 209,536 241,916 42.3 21.4

Sep-04 109.51 14.6 128.6 14.6 9,870 150,977 92,867 36.3 33.9

Oct-04 111.04 7.3 129.8 9.0 10,321 188,282 21,242 54.8 40.7

Nov-04 122.25 19.4 143.0 49.1 9,934 296,330 8,074 8.6 39.1

Dec-04 154.77 28.3 139.7 25.7 10,256 421,363 9,493 48.9 34.7

Jan-05 112.98 13.3 95.4 19.0 10,296 350,921 7,999 21.6 30.3

Feb-05 103.16 -5.5 126.1 9.2 9,384 766,800 9,840 -31.3 30.4

Mar-05 116.67 4.5 125 -4.6 10,271 271,200 11,315 110.7 42.6

Apr-05 104.65 -12.4 99.5 -12.2 9,856 205,200 18,423 29.8 40.8

May-05 110.30 -5.7 129.8 5.2 10,009 222,500 40,678 -6.9 43.4

Jun-05 112.84 -3.3 128.7 3.5 9,844 208,508 90,015 40.9 36.2

Jul-05 117.47 10.1 194.8 17.9 10,178 126,793 221,079 24.2 29.7

Aug-05 115.70 16.5 129.4 15.3 10,186 136,047 268,669 11.1 29.1

Sep-05 120.10 9.3 143.6 11.7 9,982 188,627 108,434 16.8 39.6

Oct-05 109.29 -1.9 126.3 -2.7 10,274 180,744 24,649 16.0 37.1

Nov-05 119.46 -2.4 138.9 -2.9 9,883 298,737 9,476 17.4 44.1

Dec-05 122.08 -21.2 121.5 -13.0 10,210 275,254 9,880 4.1 40.2

Jan-06 119.52 5.7 94.8 -0.6 10,330 393,562 11,988 49.9 32.2

Feb-06 108.17 4.7 116.1 -7.9 9,360 319,027 13,884 41.1 42.8

Mar-06 120.39 3.0 126.3 1.0 10,259 291,621 14,131 24.9 42.1

Note (*): Real GDP growth for 2005 is ISSP’s projection


140


REAL SECTOR Table 2: Indices of development in the various sectors of the economy

Jan- Oct 2005 07/2004 01/2005 04/2005 05/2005 06/2005 07/2005 08/2005 09/2005 10/2005 11/2005 12/2005 01/2006

Jan- Oct 2004

07/2003 =100

01/2004 =100

04/2004 =100

05/2004 =100

06/2004 =100

07/2004 =100

08/2004 =100

09/2004 =100

10/2004 =100

11/2004 =100

12/2004 =100

01/2005=100

Total 101.0 90.6 95.4 97.5 111.1 115.5 114.3 104.1 101.9 83.8 112.6 Industrial production 101.0 87.6 94.3 96.7 110.1 116.5 109.3 98.1 97.6 78.8 105.7

Forestry 107.0 27.8 161.6 164.6 135.1 98.2 120.7 111.0 208.7 105.8 71.3

Production

Construction 129.0 128.8 148.6 126.5 148.1 148.3 155.8 198.7 149.7 206.3 240.7

Road (goods) 92.0 122.9 95.1 85.5 111.8 95.7 106.2 91.3 104.5 115.7 130.2 Road( persons) 80.0 66.8 68.3 77.0 105.0 78.2 112.3 117.1 100.1 114.4 147.2

Sea (goods) 79.0 129.0 153.8 122.3 122.6 134.4 196.9 183.3 142.9 150.8 167.7 Railway (goods) 138.0 108.4 136.2 184.2 189.6 103.8 115.8 150.3 145.3 149.2 187.1

Transport

Railway (persons) 85.0 78.9 86.1 66.7 91.1 83.3 100.4 92.9 97.7 101.3 79.7

Current prices 100.0 113 114 118 104.3 114.6 100.5 105.2 104.3 110.7 98.8 Retail

trade Deflated by CPI 97.9 111.0 111.8 114.7 101.6 111.6 97.4 102.0 100.4 108.1 96.8

Current prices 113.0 41.8 65.6 123.3 104.9 101.7 105.7 115.0 78.6 91.7 131.0

Catering Deflated by CPI 110.6 41.03 64.31 119.78 102.18 98.99 102.41 111.43 75.70 89.52 128.26

CPI 102.2 101.8 102 102.9 102.7 102.7 103.2 103.2 103.8 102.4 102.1

Monet June 2006


PRICES Table 1: Prices

Consumer Price Index (Cost of Living) )110

CPI Total RPI Total Producer Price

Index

2000= 100

Monthly change in %

Annual change in % Fo

od, t

obac

co a

nd

beve

rage

s an

nual

ch

ange

s

Goo

ds le

ss f

ood,

to

bacc

o an

d be

vera

ges

annu

al

chan

ges

Serv

ices

ann

ual

chan

ges

2000= 100

Monthly change in %

Annual change in %

2000= 100

Annual change in %

PRICES IN DINARS

1995 9.8 6.2 83.7 206 6.5 100.1

1996 18.2 3.4 89.7 379 3.3 89.1

1997 22.9 1.4 26.5 456 1.1 20.8

1998 29.8 3.1 29.8 582 2.9 27.5

1999 47.1 6.2 56.6 931 7.1 58.0 85.9

DM (until December 2001) and EURO (from January 2002)

2000 100.0 3.4 36.1 10.9 23.2 12.2 100.0 25.0 100.0 16.5

2001 120.2 1.8 21.8 18.9 22.8 42.0 123.0 8.6 23.1 114.4 14.5

2002 142.0 0.7 16.8 15.7 18.7 19.5 147.6 3.1 17.4 121.6 4.6

2003 151.6 0.50 6.8 3.9 9.3 7.3 159.4 0.5 7.7 127.8 2.9

2004 155.2 0.26 2.4 0.6 3.8 9.3 164.4 0.3 3.3 138.0 5.8

2005 161.6 0.20 104.1 100.4 101.5 138.9 173.8 0.2 5.5 140.8 2.1

2004-Q1 155.0 0.1 5.5 3.9 8.1 7.7 161.9 0.1 7.1 130.9 7.6

2004-Q2 154 0.2 6.3 4.2 7.3 9.0 161.7 0.2 7.5 129.9 7.2

2004-Q3 155 0.1 5.5 3.9 8.1 7.7 161.9 0.1 7.1 130.9 7.6

2004-Q4 156.1 1.2 1.3 -1.2 2.3 20.2 166.7 0.8 3.1 138.5 4.3

2005-Q1 160.0 0.1 3.2 -1.7 1.6 42.2 172.4 0.1 5.9 139.5 3.1

2005-Q2 161.9 0.5 4.1 0.0 1.3 41.1 173.8 0.28 5.2 140.3 0.9

2005-Q3 161.3 -0.1 4.8 0.8 1.8 45.3 174.0 0.05 3.6 141.4 1.6

2005-Q4 163.0 0.4 4.4 2.3 1.5 30.7 174.9 0.1 4.3 142.1 2.6

2006-Q1 164.5 0.3 2.9 3.5 1.5 1.0 175.7 0.13 2.32 144.0 0.9

Jan-05 159.8 0.1 3.2 -1.8 1.4 53.8 172.1 0.1 6.2 130.7 3.6

Feb-05 160.0 0.1 3.1 -1.8 1.7 54.8 172.4 1.1 5.8 131.0 3.3

Mar-05 160.3 0.2 3.2 -1.6 1.7 55.8 172.7 2.1 5.9 133.8 2.5

Apr-05 161.1 0.5 3.7 -0.2 1.1 56.8 173.4 3.1 6.2 131.9 0.4

May-05 162.0 0.6 3.8 -1.0 1.8 57.8 173.8 4.1 5.8 140.2 0.5

Jun-05 162.5 0.3 4.8 1.3 0.9 38.7 174.2 5.1 3.8 141.3 1.7

Jul-05 160.9 -1.0 4.6 0.6 1.6 44.7 173.8 6.1 3.5 141.3 1.5

Aug-05 161.2 0.2 4.7 0.6 1.6 44.8 173.9 7.1 3.5 141.4 1.3

Sep-05 161.8 0.4 5.2 1.2 2.1 46.3 174.4 8.1 3.7 141.6 2.1

Oct-05 162.3 0.3 5.2 0.5 -0.1 45.3 174.8 0.2 3.3 141.6 2.1

Nov-05 163.3 0.6 5.7 1.1 -0.4 45.5 174.9 0.1 3.4 141.7 2.2

Dec-05 163.5 0.2 2.5 0.3 0.0 1.1 175.1 0.1 1.8 143.0 3.5

Jan-06 164.1 0.3 2.9 3.2 1.8 1.1 175.5 0.2 2.6 143.1 3.1

Feb-06 164.5 0.3 2.9 3.6 1.6 1.0 175.7 0.1 2.3 143.7 -2.8

Mar-06 164.9 0.2 2.8 3.8 1.2 0.9 175.9 0.1 2.1 145.2 2.3

Sources: Price indices published by Statistical Office of Montenegro except for December 2004 monthly rates of change which were calculated by ISSP. Table presents end-of-period values for monthly data and average period values for quarterly and annual data. Currencies: DIN until 1999, DM from 2000 to 2002 and € from 2002. • One-base index is calculated as a chain index according to Monstat indices, based on respective

previous years • Monthly and annual changes are based on data taken from Monstat publications except for December

2004 monthly rates of change which were calculated by ISSP

""Cost of Living" is the official name of the Consumer price index (CPI) in Montenegro


142


BUDGET Table 1: Central Budget Revenues and Expenditures, 2001-2006(jan-march), (million €) 2001 2002 2003 2004 2005 2006

Jan-Dec Jan-Dec Jan-Dec Jan-Dec Jan-Dec Jan-March

Execute Execute Execute Execute Execute Execute

Deposits from previous year

A TOTAL REVENUE AND GRANTS (1+2) 233.140 256.804 350.103 379.730 431.79 102.886

1 TOTAL REVENUE (1.1+1.2) 221.220 229.847 337.519 372.783 416.86 102.882

1.1 Current revenue (1.1.1+1.1.2) 221.220 229.847 337.519 369.696 411.89 102.869

1.1.1 Tax revenue (1.1.1.1+1.1.1.2+1.1.1.3+1.1.1.4+1.1.1.5) 187.999 208.931 312.918 337.513 382.33 94.331

1.1.1.1 Personal income tax 56.654 57.889 63.961 61.235 67.09 13.773

1.1.1.2 Turnover (sales) tax 58.488 56.528 137.222 158.096 193.38 51.025

1.1.1.3 Excises 35.664 50.786 58.197 61.527 65.60 13.951

1.1.1.4 Taxes on international trade and transactions 27.274 26.376 36.845 36.653 41.09 10.013

1.1.1.4.1 Custom tariffs 13.894 12.605 35.078 33.803 37.10 10.013

1.1.1.4.2 Custom transit fees 13.380 13.771 1.766 2.850 2.850 0.00

1.1.1.5 Other taxes 9.920 17.342 16.694 20.002 25.03 5.569

1.1.2 Non tax revenues 33.221 20.916 24.601 32.183 29.56 8.538

1.2 Capital revenue 3.087 4.97 0.013

2 GRANTS 11.920 26.958 12.584 6.947 2.50 0.004

B TOTAL EXPENDITURE AND NET LENDING (1+2) 259.309 266.771 381.090 405.487 459.71 108.371

1 TOTAL EXPENDITURE (1.1+1.2) 252.585 247.517 358.924 390.211 429.99 106.79

1.1 Current expenditure (1.1.1+1.1.2) 233.287 236.697 345.235 377.561 399.36 103.537

1.1.1 Interest 0.622 12.880 14.136 24.025 20.36 4.005 1.1.2 Non-interest expenditure (1.1.2.1+1.1.2.2+1.1.2.3+1.1.2.4+1.1.2.5+1.1.2.6) 232.665 223.818 331.099 353.536 379.00 99.532

1.1.2.1 Wages, salaries, allowances 108.464 110.178 134.262 164.389 155.93 34.339

1.1.2.2 Goods and services 55.351 41.817 37.858 46.913 57.39 11.015

1.1.2.3 Social Insurance and Social Security Transfers 45.327 35.825 132.795 103.782 117.22 34.70

1.1.2.4 Subsidies to enterprises 12.249 18.169 14.631 8.481 6.33 1.013

1.1.2.5 Reserves 6.461 14.819 8.388 16.689 29.16 2.082

1.1.2.6 Other non - interest expenditure 4.813 3.010 3.165 13.282 1.81 16.384

1.2 Capital expenditure 19.298 10.820 13.688 12.650 30.63 3.253

2 NET LENDING 6.723 19.254 22.167 15.276 7.46 1.581

Lending 13.974 19.490 22.590 17.803 2.315

Repayment 7.250 0.236 0.423 2.527 0.734

OVERALL BUDGET BALANCE EXCLUDING GRANTS (CASH) (A-B-2) -38.089 -36.925 -43.571 -32.704 -27.91 -5.489

OVERALL BUDGET BALANCE (CASH) (A-B) -26.169 -9.967 -30.987 -25.757 -30.41 -5.485

FINANCING (1+2) 26.129 38.254 18.395 23.427 62.2 -5.708

1 DOMESTIC AND FOREIGN FINANCING (NET) 17.007 0.568 6.234 19.886 -71.88 -6.356

Borrowings 76.436 40.445 48.246 51.110 0.276

Repayment 59.430 39.877 42.012 31.224 6.632

2 PRIVATIZATION REVENUE 9.122 37.686 12.161 3.541 136.31 0.648

Monet June 2006


MONEY Table 1: Monetary aggregates, in € 000

2003 2004 2005 2006

XII XII IV V VI VII VIII IX X XI XII I II

M0 284,909 290,935 296,909 305,784 307,376 309,627 324,364 325,768 321,932 325,239 351,276 336,478 328,717 Banks' deposits with CBM-Payment Operations 34,909 40,935 46,909 55,784 57,376 59,627 74,364 75,768 71,932 75,239 101,276 86,478 78,717

Estimate of cash in circulation 250,000 250,000 250,000 250,000 250,000 250,000 250,000 250,000 250,000 250,000 250,000 250,000 250,000

M1** 386,121 430,659 444,089 472,717 490,980 497,616 527,268 537,926 539,169 546,275 595,064 590,811 579,677

M0 284,909 290,935 296,909 305,784 307,376 309,627 324,364 325,768 321,932 325,239 351,276 336,478 328,717

Demand deposits in EUR 83,148 130,220 135,610 155,975 168,142 171,764 191,498 201,738 202,424 204,122 234,600 241,000 238,100

Demand deposits within banks in EUR 18,064 9,504 11,570 10,958 15,462 16,225 11,406 10,420 14,813 16,914 9,200 13,300 12,800

M11* 402,586 436,876 463,571 504,940 512,757 514,833 552,806 568,659 571,602 575,682 613,518 612,402 615,241

M0 284,909 290,935 296,909 305,784 307,376 309,627 324,364 325,768 321,932 325,239 351,276 336,478 328,717

Demand deposits in EUR 98,776 136,064 154,936 187,565 188,970 188,265 216,911 232,375 234,301 232,800 253,000 262,600 273,600

Demand deposits within banks in EUR 18,901 9,877 11,726 11,591 16,411 16,941 11,531 10,516 15,369 17,643 9,300 13,400 12,900

M2 460,837 535,550 561,341 597,896 622,851 641,495 676,574 692,596 699,274 748,723 801,053 797,866 796,651

M1 386,121 430,659 444,089 472,717 490,980 497,616 527,268 537,926 539,169 546,275 595,064 590,811 579,677

Term deposits in EUR 71,229 98,128 106,541 117,492 125,682 140,112 139,684 146,904 151,754 189,501 199,600 196,000 206,000

Term deposits in other currencies 3,487 6,763 10,711 7,687 6,189 3,767 9,622 7,766 8,351 12,947 6,300 11,100 11,000

M21 494,290 546,287 677,325 722,119 726,277 730,148 767,794 781,479 785,114 832,561 866,091 862,254 872,566

M11 402,586 436,876 463,571 504,940 512,757 514,833 552,806 568,659 571,602 575,682 613,518 612,402 615,241

Term deposits in EUR 88,203 102,648 203,043 209,492 207,331 211,548 205,366 205,054 205,161 243,932 246,200 238,700 246,300

Term deposits in other currencies 3,501 6,763 10,711 7,687 6,189 3,767 9,622 7,766 8,351 12,947 6,300 11,100 11,000

* without part of the required reserve kept in T-bills ** withou Government *** with Government


144


MONEY Table 2.a: Total deposits (in € 000)

2002 2003 2004 2005

Description/ Period XII XII XII I II

Dem

and

depo

sits

Term

dep

osits

Tota

l

Dem

and

depo

sits

Term

dep

osits

Tota

l

Dem

and

depo

sits

Term

dep

osits

Tota

l

Dem

and

depo

sits

Term

dep

osits

Tota

l

Dem

and

depo

sits

Term

dep

osits

Tota

l

1 Financial institutions 4,938 1,662 6,600 2,454 1,284 3,738 10,708 19,876 30,584 8,402 21,107 29,509 9,347 18,304 27,651 Banks 3,658 1,653 5,311 1,081 764 1,845 6,000 12,297 18,297 4,406 13,888 18,294 3,375 10,873 14,248 Domestic 485 992 1,477 489 364 853 4,840 368 5,208 3,156 395 3,551 2,385 380 2,765 Foreign 3,173 661 3,834 592 400 992 1,160 11,929 13,089 1,250 13,493 14,743 990 10,493 11,483

Other financial institutions 1,280 9 1,289 1,373 520 1,893 4,708 7,579 12,287 3,996 7,219 11,215 5,972 7,431 13,403

Domestic 1,262 9 1,271 1,359 520 1,879 4,577 6,679 11,256 3,865 6,319 10,184 5,941 6,531 12,472 Foreign 18 0 18 14 0 14 131 900 1,031 131 900 1,031 31 900 931 2 Non financial instititions 69,331 30,999 100,330 69,942 40,042 109,984 69,630 33,958 103,588 59,519 31,970 91,489 59,002 31,161 90,163

Public non financial corporations 22,779 7,347 30,126 12,037 9,986 22,023 11,477 13,352 24,829 6,613 13,076 19,689 6,640 11,843 18,483

State companies 3,746 3,667 7,413 4,670 4,791 9,461 4,360 9,356 13,716 4,902 9,200 14,102 4,769 8,978 13,747

Publicly owned organizations 19,033 3,680 22,713 7,367 5,195 12,562 7,117 3,996 11,113 1,711 3,876 5,587 1,871 2,865 4,736

Other non financial corporations 46,552 23,652 70,204 57,905 30,056 87,961 58,153 20,606 78,759 52,906 18,894 71,800 52,362 19,318 71,680

Domestic private companies 41,972 23,370 65,342 52,640 28,916 81,556 53,893 16,798 70,691 48,539 16,576 65,115 48,084 16,022 64,106

Entrepreneurs 0 0 1,063 2 1,065 1,227 12 1,239 1,188 12 1,200 Foreign companies 4,580 282 4,862 5,265 1,140 6,405 3,197 3,806 7,003 3,140 2,306 5,446 3,090 3,284 6,374 3 Government 58,238 11,078 69,316 19,402 25,685 45,087 18,122 28,111 46,233 24,457 29,053 53,510 21,352 29,062 50,414

Central government 40,221 7,077 47,298 5,738 8,223 13,961 6,184 4,507 10,691 7,996 4,516 12,512 8,147 4,416 12,563

Agencies and institutions of central government 13,907 1,246 15,153 9,468 258 9,726 6,356 6,339 12,695 9,757 7,339 17,096 6,072 7,351 13,423

Local government - municipalities 339 44 383 1,324 10 1,334 1,843 186 2,029 1,958 436 2,394 1,888 396 2,284

State funds 3,771 2,711 6,482 2,872 17,194 20,066 3,739 17,079 20,818 4,746 16,762 21,508 5,245 16,899 22,144 4 Physical entities 11,469 10,743 22,212 22,206 22,864 45,070 40,064 39,211 79,275 35,620 41,465 77,085 45,877 45,104 90,981

Domestic 11,469 10,743 22,212 22,206 22,864 45,070 36,862 37,288 74,150 31,459 39,601 71,060 34,782 43,100 77,882 Foreign 0 0 3,202 1,923 5,125 4,161 1,864 6,025 11,095 2,004 13,099 5 Non profit organizations 1,315 1,229 2,544 2,452 1,285 3,737 5,089 171 5,260 5,368 194 5,562 5,086 243 5,329

Domestic 298 234 532 1,601 235 1,836 3,928 110 4,038 4,816 110 4,926 3,940 159 4,099 Foreign 1,017 995 2,012 851 1,050 1,901 1,161 61 1,222 552 84 636 1,146 84 1,230 6 Other 2,954 1,574 4,528 1,376 2,016 3,392 7,886 371 8,257 7,433 522 7,955 7,370 1,260 8,630

TOTAL 148,245 57,285 205,530 117,832 93,176 211,008 151,499 121,698 273,197 140,799 124,311 265,110 148,034 125,134 273,168

Monet June 2006


MONEY Table 2.b: Total deposits (in € 000)

2005

Description/ Period III IV V VI VII

Dem

and

depo

sits

Term

dep

osits

Tota

l

Dem

and

depo

sits

Term

dep

osits

Tota

l

Dem

and

depo

sits

Term

dep

osits

Tota

l

Dem

and

depo

sits

Term

dep

osits

Tota

l

Dem

and

depo

sits

Term

dep

osits

Tota

l

1 Financial institutions 30,486 23,632 54,118 14,168 30,670 44,838 11,282 28,694 39,976 15,054 30,301 45,355 15,223 23,136 41,359 Banks 1,765 14,244 16,009 3,511 11,922 15,433 4,119 9,436 13,555 3,113 11,709 14,822 4,292 8,066 12,358 Domestic 1,256 773 2,029 2,350 919 3,269 3,528 802 4,060 2,342 830 3,172 3,047 827 3,874 Foreign 509 13,471 13,980 1,161 11,003 12,164 861 8,634 9,495 771 10,879 11,650 1,245 7,240 8,485

Other financial institutions 28,721 9,388 38,109 10,657 18,748 29,405 7,163 19,258 26,421 11,941 18,592 30,533 10,931 18,069 29,000

Domestic 28,680 8,488 37,168 10,512 17,848 28,360 6,883 18,358 25,241 11,539 17,692 29,231 10,289 17,169 27,458 Foreign 41 900 941 145 900 1,045 280 900 1,180 402 900 1,302 642 900 1,542 2 Non financial instititions 57,282 30,981 88,263 56,655 27,979 84,634 80,217 31,206 111,423 88,501 36,114 124,615 84,372 42,441 126,813


State companies 6,173 9,592 15,765 5,987 5,666 11,653 5,548 4,113 9,661 10,144 5,528 15,672 8,570 7,175 15,745




Entrepreneurs 1,321 12 1,333 1,424 2 1,426 1,413 2 1,415 1,554 13 1,567 2,026 13 2,039 Foreign companies 4,128 4,020 8,148 5,591 4,020 9,611 4,694 5,020 9,714 5,537 6,745 12,282 5,667 7,575 13,242 3 Government 20,753 28,813 49,566 28,267 25,995 54,262 34,536 32,943 67,479 25,346 27,979 53,325 25.432 26,075 51,507


Agencies and institutions of central government 9,377 5,744 15,121 9,553 3,686 13,239 8,399 4,412 12,811 9,585 2,690 12,275 9,184 3,317 12,501

Local government - municipalities 1,498 219 1,717 1,333 316 1,649 2,826 97 2,923 2,631 107 2,738 2,943 46 2,989


Domestic 37,530 42,963 80,493 41,698 45,493 87,191 42,254 48,959 91,213 47,480 55,725 103,205 54,348 59,612 113,960 Foreign 6,042 6,698 12,740 10,096 4,187 14,283 7,637 4,728 12,365 8,940 3,630 12,570 9,905 3,450 13,355 5 Non profit organizations 5,177 243 5,420 4,227 243 4,470 6,401 303 6,704 6,808 358 7,166 7,532 370 7,903

Domestic 3,335 159 3,494 3,943 159 4,102 5,415 241 5,656 5,705 296 6,001 6,292 273 6,565 Foreign 1,842 84 1,926 284 84 368 986 62 1,048 1,103 62 1,165 1,240 97 1,337 6 Other 8,006 464 8,470 9,869 255 10,124 6,948 350 7,298 4,882 321 5,203 4,782 374 5,157

TOTAL 165,276 133,794 299,070 164,980 134,822 299,802 189,275 147,183 336,458 197,011 154,428 351,439 201,595 158,458 360,053


146


MONEY Table 2.c: Total deposits (in € 000)

2005

Description/ Period VIII IX X XI XII

Dem

and

depo

sits

Term

dep

osits

Tota

l

Dem

and

depo

sits

Term

dep

osits

Tota

l

Dem

and

depo

sits

Term

dep

osits

Tota

l

Dem

and

depo

sits

Term

dep

osits

Tota

l

Dem

and

depo

sits

Term

dep

osits

Tota

l

1 Financial institutions 16,540 27,745 44,285 17,578 24,377 41,955 18,541 23,382 41,923 14,343 26,498 40,841 12,593 27,477 40,070 Banks 4,140 10,642 14,783 4,411 8,160 12,571 3,855 8,740 12,595 2,235 10,772 13,007 2,732 15,248 17,980 Domestic 3,554 821 4,375 3,726 829 4,555 3,171 412 3,583 1,544 1,424 2,968 2,004 1,000 3,004 Foreign 587 9,821 10,408 685 7,331 8,016 684 8,328 9,012 691 9,348 10,039 728 14,248 14,976

Other financial institutions 12,400 17,103 29,503 13,167 16,217 29,384 14,686 14,642 29,328 12,108 15,726 27,834 9,861 12,229 22,090

Domestic 11,163 16,203 27,365 11,072 15,317 26,389 10,874 13,742 24,616 10,912 12,716 23,628 9,657 10,726 20,383 Foreign 1,237 900 2,137 2,095 900 2,995 3,812 900 4,712 1,196 3,010 4,206 204 1,503 1,707 2 Non financial instititions 94,202 47,769 141,971 91,506 49,724 141,230 92,449 46,137 138,586 92,113 47,087 139,200 112,700 49,271 161,971


State companies 11,348 8,067 19,415 9,851 8,900 18,751 9,166 9,281 18,447 7,909 9,154 17,063 12,189 8,156 20,345




Entrepreneurs 2,081 13 2,094 2,050 14 2,064 1,666 12 1,678 2,107 12 2,119 1,438 13 1,451 Foreign companies 4,871 6,896 11,767 5,231 7,575 12,806 5,564 7,845 13,409 5,425 7,057 12,482 5,431 8,062 13,493 3 Government 30,059 25,784 55,843 43,899 25,194 69,093 37,541 27,515 65,056 35,874 67,638 103,512 30,586 67,250 97,836


Agencies and institutions of central government 1,054 4,461 14,515 12,235 4,762 16,997 10,378 4,807 15,185 10,992 4,897 15,889 7,874 6,560 14,434

Local government - municipalities 3,272 17 3,289 3,929 7 3,936 3,503 7 3,510 3,485 7 3,492 3,191 987 4,178


Domestic 57,647 57,727 115,374 65,467 61,671 127,138 68,502 65,580 134,082 74,498 71,473 145,971 81,179 76,185 157,364 Foreign 9,515 4,295 13,810 10,060 4,219 14,279 11,817 5,549 17,366 12,262 6,079 18,341 12,323 6,063 18,386 5 Non profit organizations 8,506 407 8,913 8,222 352 8,574 9,141 5,054 14,195 7,790 5,055 12,845 8,940 517 9,457

Domestic 7,113 345 7,458 7,112 254 7,366 7,224 4,991 12,215 6,540 4,992 11,532 7,226 454 7,680 Foreign 1,392 62 1,455 1,110 98 1,208 1,917 63 1,980 1,250 63 1,313 1,714 63 1,777 6 Other 3,407 372 3,780 3,462 312 3,774 3,141 315 3,456 2,994 325 3,319 2,407 425 2,832

TOTAL 219,877 164,099 383,976 240,194 165,849 406,043 241,132 173,532 414,664 239,874 224,155 464,029 260,728 227,188 487,916

Monet June 2006


MONEY Table 2.d: Total deposits (in € 000)

2006

Description/ Period I II III IV V

Dem

and

depo

sits

Term

dep

osits

Tota

l

Dem

and

depo

sits

Term

dep

osits

Tota

l

Dem

and

depo

sits

Term

dep

osits

Tota

l

Dem

and

depo

sits

Term

dep

osits

Tota

l

Dem

and

depo

sits

Term

dep

osits

Tota

l

1 Financial institutions 16,054 18,372 34,426 15,333 19,553 34,886 Banks 4,715 5,728 10,443 2,561 7,744 10,305 Domestic 3,476 1,000 4,476 1,910 1,500 3,410 Foreign 1,239 4,728 5,967 651 6,244 6,895

Other financial institutions 11,339 12,644 23,983 12,772 11,809 24,581

Domestic 11,021 11,141 22,162 12,367 10,320 22,687 Foreign 318 1,503 1,821 405 1,489 1,894 2 Non financial instititions 113,429 42,096 155,525 121,971 44,827 166,798

Public non financial corporations 14,594 10,423 25,017 13,817 10,471 24,288

State companies 11,998 8,210 20,208 11,274 8,665 19,939

Publicly owned organizations 2,596 2,213 4,809 2,543 1,806 4,349

Other non financial corporations 98,835 31,673 130,508 108,154 34,356 142,510

Domestic private companies 91,662 24,027 115,689 100,832 27,691 128,523

Entrepreneurs 1,655 3 1,658 1,680 3 1,683 Foreign companies 5,518 7,643 13,161 5,642 6,662 12,304 3 Government 32,149 71,345 103,494 34,527 76,169 110,696

Central government 13,084 6,515 19,599 21,474 6,403 27,877

Agencies and institutions of central government 8,559 6,651 15,210 7,307 7,432 14,739

Local government - municipalities 6,524 1,755 8,279 2,837 4,954 7,791

State funds 3,982 56,424 60,406 2,909 57,380 60,289 4 Physical entities 99,692 86,419 186,111 91,576 89,571 181,147

Domestic 86,159 80,274 166,433 76,694 83,457 160,151 Foreign 13,533 6,145 19,678 14,882 6,114 20,996 5 Non profit organizations 8,120 750 8,870 8,827 705 9,532

Domestic 6,436 527 6,963 7,192 407 7,599 Foreign 1,684 223 1,907 1,635 298 1,933 6 Other 2,676 313 2,989 2,759 296 3,055

TOTAL 272,120 219,295 491,415 274,993 231,121 503,114


148


MONEY Table: Household deposits (in 000 €)

1.Demand deposits

2. Term savings up to 1 year

3. Term savings over 1 year

Total (1+2+3)

Dec-00 2034 428 2 2465Oct-01 1750 655 56 2462Nov-01 2092 809 466 3367Dec-01 3516 1557 549 5623Jan-02 2843 2089 617.13 5550Feb-02 2791 2336 702 5829Mar-02 4139 3418 741 8298Apr-02 4874 4443 773 10090May-02 4329 4732 525 9586Jun-02 4629 5609 615 10853Jul-02 5036 6089 702 11827Aug-05 4269 7217 928 12414Sep-02 3984 7669 1663 13316Oct-05 5686 8012 1038 14736Nov-02 5205 9515 1099 15819Dec-02 11370 9650 1127 22147Jan-03 11122 10326 1188 22636Feb-03 11339 10926 1194 23459Mar-03 9887 14446 1166 25499Apr-03 13409 13466 1179 28054May-03 11379 13368 1199 25946Jun-03 12133 13848 1340 27321Jul-03 14433 13386 1463 29282Aug-05 16917 14576 1522 33015Sep-03 16967 16512 1554 35033Oct-05 19863 18983 1633 40479.Nov-03 19502 19851 1658 41011Dec-03 22559 20258 2341 45158Jan-04 18560 20639 3331 42530Feb-04 18359 23115 2987 44461Mar-04 20865 24108 2525 47498Apr-04 22730 25102 2647 50479May-04 22314 26104 2914 51332Jun-04 22986 26393 3254 52633Jul-04 26320 26592 3770 56682Aug-04 28716 28277 3327 60320Sep-04 29980 30168 3407 63555Oct-04 35105 28203 6786 70094Nov-04 33571 33388 3743 70702Dec-04 40143 36097 4433 80673Jan-05 35621 36794 4722 77283Feb-05 45877 40828 4267 90982Mar-05 43573 34753 14902 93234Apr-05 51794 35366 14306 101474May-05 49892 39112 14551 103579Jun-05 56420 42583 16771 115776Jul-05 64253 47323 15739 127315Aug-05 67162 47053 14969 129184Sep-05 75527 53238 12652 141417Okt-05 80318 58417 12712 151447Nov-05 86757 59042 18508 164307

Dec-05 93500 62600 19700 175800

Jan-06 99700 83300 3200 186200

Feb-06 91600 87000 2400 181100

Monet June 2006


MONEY Table 4: Total loans (in € 000)

2002 2003 2004 2005 2006

XII XII XII IV V VI VII VIII IX X XI XII I II

1 Financial institutions 788 1,695 3,854 292 435 1,868 1,913 1,947 1,840 1,578 1,442 136 132 428

Banks 35 1,525 1,000 50 204 4 29 29 26 25 24 37 36 34

Domestic 35 1,525 1,000 50 204 4 29 29 26 25 24 37 36 34

Foreign 0 0 0 0 0 0 0 0 0 0 0 0 0 0

Other financial institutions 753 170 2,854 242 231 1,864 1,884 1,918 1,814 1,553 1,418 99 96 394

Domestic 753 170 2,819 238 231 1,864 1,884 1,918 1,814 1,553 1,418 99 96 394

Foreign 0 0 35 4 0 0 0 0 0 0 0 0 0 0

2 Non financial institutions 80,984 128,338 184,298 207,570 210,899 218,408 215,764 220,676 217,931 226,419 231,149 239,633 247,192 268,159

Public non financial institutions 10,641 14,186 18,248 24,377 21,962 22,562 21,847 22,743 20,129 23,773 25,398 27,109 28,714 31,401

State companies 8,448 12,413 10,545 15,834 14,869 14,905 14,148 15,360 14,075 16,166 17,922 19,646 21,245 23,457

Publicly owned organizations 2,193 1,773 7,703 8,543 7,093 7,656 7,699 7,383 6,054 7,607 7,476 7,463 7,469 7,944

Other non financial corporations 70,343 114,152 166,050 183,193 188,937 195,846 193,917 197,933 197,802 202,646 205,751 212,524 218,478 236,758

Domestic private companies 70,305 114,148 159,278 177,121 182,578 189,532 187,686 191,892 191,772 196,596 199,504 206,060 212,002 229,068

Entrepreneurs 5,768 4,263 4,409 4,448 4,367 4,183 4,164 4,189 4,361 4,386 4,481 4,678

Foreign companies 38 4 1,004 1,809 1,950 1,867 1,864 1,858 1,866 1,861 1,886 2,078 1,995 3,012

3 Government 20,531 20,570 18,758 27,638 24,241 27,498 23,924 28,019 26,770 25,547 31,708 30,785 32,393 35,839

Central government 16,373 16,495 9,162 5,097 5,080 3,382 3,167 3,172 3,082 3,179 7,589 9,864 12,416 13,530

Agencies and institutions of central

government 916 141 405 387 387 1,208 1,303 1,303 1,251 1,240 2,217 5,409 5,290 5,218

Local government - municipalities 842 910 1,735 2,743 3,163 3,027 3,797 5,017 4,993 3,756 3,958 3,809 3,709 3,978

State funds 2,400 3,024 7,456 19,411 15,611 19,881 15,657 18,530 17,444 17,372 17,944 11,703 10,978 13,113

4 Physical entities 22,290 49,959 74,393 79,014 83,688 88,013 90,043 90,377 92,154 98,444 101,869 104,316 107,229 110,731

Domestic 22,290 49,959 74,304 78,927 83,561 87,896 89,932 90,271 92,049 98,342 101,758 104,208 107,136 110,639

Foreign 89 87 127 117 111 106 105 102 111 108 93 92

5 Non profit organizations 70 63 180 1,301 784 845 850 822 882 5,495 5,298 943 922 969

Domestic 70 63 180 227 784 845 848 822 882 5,495 5,298 943 922 969

Foreign 0 0 0 1,074 0 0 2 0 0 0 0 0 0 0

6 Other 0 0 0 0 0 0 0 31 23 8 127 127 125

TOTAL 124,663 200,625 281,483 315,815 320,047 336,631 332,494 341,840 339,608 357,506 371,474 375,940 387,995 416,251


150


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